Roth IRAs wear many hats. They provide a vehicle for tax-free growth, they permit early access to savings if needed, and they eliminate mandatory distributions in retirement, enabling wealthy seniors to pass along a potentially bigger financial legacy to their heirs. It’s no wonder that Roth IRA conversions have become such a coveted tax planning tool.
Roth conversions involve shifting money from a tax-deferred retirement account, such as a traditional IRA or a 401(k), which do not limit contributions based on income, into a Roth IRA, which does have income limits for eligibility. The money converted is subject to ordinary income tax in the year it gets converted, but all future earnings grow tax free.
Most who convert all or part of their retirement savings to a Roth do so to reduce their future tax hit in retirement, which is particularly appealing for individuals who have only ever saved in tax-deferred accounts. And many are high-income taxpayers who were never eligible to contribute directly to a Roth IRA based on their earnings.
Who should consider doing a Roth conversion?
Despite their potential benefits, however, Roth IRA conversions are not necessarily the right move for everyone. And they’re irreversible. Thus, anyone considering such a move should consult a financial professional for guidance.
As a general rule of thumb, you might want to consider a Roth conversion if you think your tax rate may be higher in retirement. Indeed, while most retirement savers project a lower tax rate in retirement, the reality is that many who saved primarily in tax-deferred accounts face a higher tax rate when they begin taking taxable withdrawals.
- Diligent young savers who expect their incomes to climb over the years.
- Older individuals whose tax bills could jump when they start taking required minimum distributions
- Big savers who want to reduce future tax bills for themselves or their heirs.
- Conversions can make sense if the IRA owner expects to be in the same or a higher tax bracket in retirement
Types of retirement accounts can be converted to a Roth IRA:
- Traditional IRA
- Rollover IRA
- SEP IRA
- SIMPLE IRA (only after the SIMPLE IRA account has been held for at least 2 years)
- Employer retirement plan (401, 403(b), and 457(b)) assets
- Future withdrawals are tax-free (if meeting Roth Distribution rules)
- No required minimum distributions
- Passes to heirs tax free
- A key benefit of doing a Roth IRA conversion is that it can lower your taxes in the future. While there’s no upfront tax break with Roth IRAs, your contributions and earnings grow tax-free.
Roth IRA conversions offer numerous tax advantages. Depending on your income and account value, however, the window for doing a conversion may be closing.
Those considering the impact of pending legislation on their retirement plan should consult a financial or tax professional for guidance.
This commentary was originally posted by Shelly Gigante Oct 18 2021
**Disclaimer: This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, tax, legal or accounting advice. You should consult your own tax, legal and accounting advisors before engaging in any transaction.