Roth Conversions

Do you believe that your tax rate today is less than it will be during retirement? If you've saved heavily for retirement in IRA and 401k accounts, you may be enjoying the tax-deferral while you're working but setting yourself up for a hefty tax bill when you begin taking withdrawals. Roth IRA conversions may be a viable option for savvy retirement planning, helping to reduce your future tax obligations.

Who Qualifies For Roth Conversions?

Even if your income level precludes you from making direct Roth IRA contributions, you may be eligible for a Roth conversion. Roth conversions can take a variety of forms including converting a Traditional IRA to a Roth IRA, and converting a pre-tax 401(k) or 403(b) account into a Roth IRA. In addition to these common conversions, there are other more complex forms. A Plan 4, Inc. financial advisor can help you determine if a Roth conversion is right for you.

How is a Roth IRA Different From Other Retirement Accounts?

Contributions to a Roth IRA are made after-tax, but once the money is deposited into the retirement account, it continues to grow tax-free. And, withdrawals taken after age 59 1/2 are tax-free. Importantly, unlike traditional retirement accounts, there are no required minimum distributions for the original account holder. So, while you pay taxes on Roth IRA monies initially, and you therefore can't reduce your taxable income by the amount of the contribution, once you've paid the initial taxes on the contribution, all earnings in the Roth account remain tax-free and there is no requirement to take withdrawals from the account.

A Roth IRA offers tax deferral on any earnings in the account. Qualified withdrawals of earnings from the account are tax-free. Withdrawals of earnings prior to age 59 ½ or prior to the account being opened for 5 years, whichever is later, may result in a 10% IRS penalty tax. Limitations and restrictions may apply.

What are the Benefits of Roth IRA Conversions?

The chief benefit of Roth conversions is as a retirement planning tool. Primarily, the account owner will realize tax deferred growth and tax-free withdrawals, as well as avoid required minimum distributions from the account. Since you won't pay taxes no matter how much you withdraw, a Roth IRA can be useful if you have a medical emergency or wish to use the funds to pay for care in a skilled nursing facility.

However, Roth conversions also have distinct advantages as an estate planning tool. If you're incorporating Roth IRAs into your estate plan, your beneficiaries will not be required to pay taxes on withdrawals from the inherited account. In addition, while beneficiaries of Roth IRAs will be required to deplete the account by the end of ten years, they can wait until year ten to withdraw the entire balance, tax-free and with ten additional years of tax-deferred growth. but you don't have to deplete them until the end of that ten years.

Bear in mind, however, that with Roth IRAs and other tax-deferred retirement vehicles, time is on your side. You'll want to do your conversions as early as possible to realize the maximum benefit from tax-deferred growth in the account.

Frequently Asked Questions

How do Roth conversions work?

You may transfer retirement funds from most traditional retirement accounts to a Roth account, allowing subsequent earnings and distributions to be tax-free. When you convert, you'll have to pay taxes on the funds being transferred to the Roth account but the money will continue to grow and be distributed tax-free.

What is the five-year rule for Roth conversions?

The IRS may assess taxes on withdrawals from a Roth IRA account if you take a distribution within five years of your first contribution to a Roth IRA account. The 5-year rule applies to both direct Roth IRA contributions and Roth conversions, regardless of age.

Does a Roth conversion count as an RMD?

Roth conversions will not count as a required minimum distribution (RMD). However, you may convert your retirement funds to a Roth account after you've taken an RMD for the current tax year. You may use the proceeds of the RMD to pay the taxes due from the conversion.

Do You Need Help With Roth Conversions?

Retirement planning typically includes anticipating the taxes you'll pay on retirement income, and savvy management of your retirement accounts can minimize your tax burden. Planning when and how much to convert from your traditional accounts ensures that you'll keep as much of your investment as possible. Our experienced team of financial advisors at Plan 4, Inc. can help with your Roth IRA investments and conversions.

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