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Consider Year-End Roth Conversions for Retirement Tax Savings

Have you ever thought of converting your traditional IRA to a Roth IRA? How about your 401(k)? If you’ve ever wondered whether a Roth conversion is a good move for your retirement savings plan, this is for you! 

A Roth conversion might make sense if you’re saving for retirement and want to let more of your money grow tax-free. They’re also quite handy if you think you’ll be in a higher income tax bracket upon retirement. In many cases, Roth conversions are part of a well-rounded retirement investment plan - but you’ll have to determine what’s right for your situation.

Understand the basics of Roth conversions and learn how they can play into your retirement planning decisions.

The Basics of Roth Conversion for Retirees - What Is a Roth IRA (and How Is It Different from a Traditional IRA)

A Roth IRA is a specific type of Individual Retirement Account (IRA) often used to set aside money for retirement. A Roth IRA lets you pay taxes upfront when the money goes into the account, so you can make future withdrawals tax-free.

The combined total contributions you make each year to all of your IRAs (traditional and Roth) can't be more than $6,000 ($7,000 if you're age 50 or older). This is subject to change each year. Also, you can't contribute to a Roth IRA if you make more than $139,000 (single) or more than $206,000 (married couples). 

The main difference between a Roth IRA and a traditional IRA is how they’re taxed. 

  • Traditional IRA contributions are tax-deductible in the year they’re made; you’ll pay taxes on withdrawals when you take them
  • Roth IRA contributions are not tax-deductible, but you don’t pay taxes on withdrawals in retirement

While younger investors tend to fund their Roth IRAs through regular contributions, individuals closer to retirement may not have that option because of the income limitations. With a Roth conversion, where you convert a portion of your Traditional IRA assets to Roth IRA assets, there are no income limits. It’s important to note, any money you convert from your Traditional IRA to your Roth IRA is considered taxable income in that year. Often, investors choose to pay these taxes directly from other assets so they can move the maximum amount over to their Roth IRA. 

Since you “pay upfront” when you make a Roth IRA conversion, you can let this money grow as long as you want. All earnings and contributions are tax-free when withdrawn from your Roth IRA account. This flexibility is one of the many reasons investors love Roth conversions as a retirement saving tool. 

The Benefits of Doing a Roth Conversion

Roth IRAs are widely available, making them a great choice for many retirement planners. Here are a few of the most common situations where it makes sense to do a Roth Conversion: 

  • Retirees can use Roth conversions as a way to balance their mix of tax-free, tax-deferred, and taxable accounts. We use this same strategy, known as the “Tax Triangle” to help our clients minimize the amount of tax they pay on their retirement savings.
  • With a Roth IRA, you don’t have to take Required Minimum Distributions (RMDs), unlike with traditional IRAs. Leave it in longer and let it grow, or take it out now. The choice is yours (as long as it aligns with your long-term financial plan). 
  • If your income is too high to contribute directly to a Roth IRA, you can still contribute to a traditional IRA and then convert it to a Roth. This is just one more way to manage your tax liability and convert more money to tax-free. 
  • If you have a 401(k) from a current or even an old job, you might consider converting it to a Roth IRA. You could save on fees without sacrificing returns. You’ll need to choose how and where you want to invest the money, as well as asking for a “direct rollover”. 

A fiduciary financial advisor can help you assess your specific situation to determine whether a Roth conversion is a good idea. 

What You Should Consider Before Making a Roth Conversion

As with most financial transactions, Roth conversions have income and tax implications. Understand the specifics when deciding if a Roth conversion is right for you: 

  1. If you’re debating a Roth conversion, the main thing to consider is your current and future tax rates. In other words, do you anticipate being in a higher income tax rate in retirement vs now?
  2. If you’re receiving Social Security or Medicare benefits, a Roth conversion could potentially increase your taxable income and thereby your Medicare costs. Make sure to crunch the numbers before making any moves.
  3. Converting earlier in the year gives you more time to pay the taxes on your converted balances. However, a conversion must be completed by December 31 to be included in that year's taxable income. These facts can help you plan the timing of your Roth conversion. 
  4. Converting as soon as you retire gives you more time to reap the benefits of the tax tradeoff - and the growth - before withdrawing the money from your Roth IRA. Many retirees use this strategy in their 60’s before they have to begin taking Required Minimum Distributions (RMDs) from their Traditional IRAs. 

So, to convert or not to convert? As you can see, there are a number of moving parts that play into your decision. If you’d like some assistance in deciding the best move, or in making the transfer seamlessly, your financial advisor can help. A professional not only helps you make strategic decisions; they will also make sure you won’t incur any penalties.

IRAs may not be the most exciting part of retirement planningcertainly not as much fun as hitting the farmer’s market or exploring Denver’s craft beer scene. The good news is, once you have the nuts and bolts out of the way, you can start preparing for the future you want.  

Speaking of your future, have you thought about your retirement goals? About your target retirement date and how much you need to save to meet it? Create a game plan now for a successful retirement later - with our 2021 Essential Retirement Guide.

2022 Essential Retirement Guide

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