Tips for converting a traditional IRA to a Roth IRA.
Converting
a Traditional IRA to a Roth IRA can be worthwhile, but timing matters. Deciding
when to make this “Roth Conversion” primarily depends on whether you expect
your current tax rate now to be lower than your future tax rates.
When
a Roth Conversion Makes Sense
Here
are a few times when a Roth conversion might be a good idea.
●
Lower Income Year. A good time to switch to a Roth IRA is usually when
you make less money. That’s because the tax cost of making the switch may be
more manageable.
●
Down Market Year. You can also convert when there is a drop in the
stock market. That’s because your IRA balance is temporarily lower, and you may
be able to convert the same investments at a lower tax cost and let any future
recovery happen inside the Roth. That growth can later come out tax-free if you
meet the Roth IRA guidelines.
What
to Consider Before Converting
The
potential tradeoff of converting is that you pay taxes now in exchange for more
tax flexibility in the future. Here are a few things to consider:
●
Tax Bracket: Current vs Future. If you anticipate being in a higher
tax bracket in the future, converting to a Roth is more attractive.
●
The Five-Year Rule. Roth IRAs have a general five-year rule for tax-free
qualified distributions. Every time you convert, it starts a new five-year
window in which you must wait to make withdrawals penalty-free if you are under
the age of 59½. If you convert to Roth frequently, it can create multiple
waiting periods to track.
●
Required Distributions. Unlike Traditional IRAs, Roth IRAs
don’t require you to take an annual distribution, required minimum
distributions (RMD). Traditional IRAs also require you to take annual
withdrawals starting at age 73; Roth does not. That’s what makes the Roth good
for long-term planning, tax planning, and building wealth.
●
Paying Taxes. Many people prefer to pay the conversion tax from cash
outside the IRA. Using IRA assets to cover the tax can reduce the amount that
stays invested, and if you are under 59½, it can also create extra penalties on
the amount withdrawn for taxes, per the IRS.
●
Irreversibility. Since 2018, Roth IRA conversions generally cannot be
recharacterized back into a traditional IRA. Once you convert, you usually
cannot undo it later, according to the IRS.
Benefits
of Conversion
A
Roth conversion may help you:
●
Lock in taxes at today’s rate rather than a potentially
higher future rate
●
Avoid required minimum distributions (RMD)
●
Tax-free withdrawal potential in retirement
●
Estate planning flexibility for heirs
●
Tax diversification (so that not all retirement income
depends on one tax treatment)
Downsides
of Roth Conversion
It
may not be the best move if:
●
You anticipate being in a lower bracket in the future
●
Conversion pushes you into a higher tax bracket
●
Extra income impacts Medicare premiums, tax credits, or
taxation of other income
●
You need the money earlier than retirement
●
Don’t have cash outside the IRA to pay the tax bill
Steps
to Consider
Before
converting, it helps to follow a simple process:
- Estimate how
much of the conversion will be taxable.
- Project
whether that amount would move you into a higher bracket.
- Decide if you
should convert all at once or in smaller pieces over several years.
- Make sure
you have cash to cover the taxes.
- Check on how
soon you may need the money, because of the five-year rules.
- Review
your plan with a tax professional. Is the conversion too
big? Are you close to Medicare or other income thresholds?
Bottom
Line on Roth Conversion
A
Roth conversion can be a savvy financial move, especially in lower-income years
or after a market drop. The best decision always depends on your individual tax
situation now, your expected tax bracket later, how long you leave the money
invested, and if you can pay the taxes now.
Do One Thing: Before converting your
IRA into a Roth IRA, consider all the consequences thoroughly.
*Information in our blog posts are made
available to you as self-help tools for your independent use. We cannot and do
not guarantee their accuracy, their applicability to your circumstances or
guarantee of credit. We encourage you to seek personalized advice from
qualified professionals regarding all personal finance issues.
Tips
for converting a traditional IRA to a Roth IRA.
Converting
a Traditional IRA to a Roth IRA can be worthwhile, but timing matters. Deciding
when to make this “Roth Conversion” primarily depends on whether you expect
your current tax rate now to be lower than your future tax rates.
When
a Roth Conversion Makes Sense
Here
are a few times when a Roth conversion might be a good idea.
●
Lower Income Year. A good time to switch to a Roth IRA is usually when
you make less money. That’s because the tax cost of making the switch may be
more manageable.
●
Down Market Year. You can also convert when there is a drop in the
stock market. That’s because your IRA balance is temporarily lower, and you may
be able to convert the same investments at a lower tax cost and let any future
recovery happen inside the Roth. That growth can later come out tax-free if you
meet the Roth IRA guidelines.
What
to Consider Before Converting
The
potential tradeoff of converting is that you pay taxes now in exchange for more
tax flexibility in the future. Here are a few things to consider:
●
Tax Bracket: Current vs Future. If you anticipate being in a higher
tax bracket in the future, converting to a Roth is more attractive.
●
The Five-Year Rule. Roth IRAs have a general five-year rule for tax-free
qualified distributions. Every time you convert, it starts a new five-year
window in which you must wait to make withdrawals penalty-free if you are under
the age of 59½. If you convert to Roth frequently, it can create multiple
waiting periods to track.
●
Required Distributions. Unlike Traditional IRAs, Roth IRAs
don’t require you to take an annual distribution, required minimum
distributions (RMD). Traditional IRAs also require you to take annual
withdrawals starting at age 73; Roth does not. That’s what makes the Roth good
for long-term planning, tax planning, and building wealth.
●
Paying Taxes. Many people prefer to pay the conversion tax from cash
outside the IRA. Using IRA assets to cover the tax can reduce the amount that
stays invested, and if you are under 59½, it can also create extra penalties on
the amount withdrawn for taxes, per the IRS.
●
Irreversibility. Since 2018, Roth IRA conversions generally cannot be
recharacterized back into a traditional IRA. Once you convert, you usually
cannot undo it later, according to the IRS.
Benefits
of Conversion
A
Roth conversion may help you:
●
Lock in taxes at today’s rate rather than a potentially
higher future rate
●
Avoid required minimum distributions (RMD)
●
Tax-free withdrawal potential in retirement
●
Estate planning flexibility for heirs
●
Tax diversification (so that not all retirement income
depends on one tax treatment)
Downsides
of Roth Conversion
It
may not be the best move if:
●
You anticipate being in a lower bracket in the future
●
Conversion pushes you into a higher tax bracket
●
Extra income impacts Medicare premiums, tax credits, or
taxation of other income
●
You need the money earlier than retirement
●
Don’t have cash outside the IRA to pay the tax bill
Steps
to Consider
Before
converting, it helps to follow a simple process:
- Estimate how much of the
conversion will be taxable.
- Project whether that amount would move
you into a higher bracket.
- Decide if you should convert all at
once or in smaller pieces over several years.
- Make sure you have cash to cover the
taxes.
- Check on how soon you may need the
money, because of the five-year rules.
- Review your plan with a tax
professional. Is the conversion too big? Are you close to Medicare or
other income thresholds?
Bottom
Line on Roth Conversion
A
Roth conversion can be a savvy financial move, especially in lower-income years
or after a market drop. The best decision always depends on your individual tax
situation now, your expected tax bracket later, how long you leave the money
invested, and if you can pay the taxes now.
Do
One Thing:
Before converting your IRA into a Roth IRA, consider all the consequences
thoroughly.
*Information
in our blog posts are made available to you as self-help tools for your
independent use. We cannot and do not guarantee their accuracy, their
applicability to your circumstances or guarantee of credit. We encourage you to
seek personalized advice from qualified professionals regarding all personal
finance issues.
Tips
for converting a traditional IRA to a Roth IRA.
Converting
a Traditional IRA to a Roth IRA can be worthwhile, but timing matters. Deciding
when to make this “Roth Conversion” primarily depends on whether you expect
your current tax rate now to be lower than your future tax rates.
When
a Roth Conversion Makes Sense
Here
are a few times when a Roth conversion might be a good idea.
●
Lower Income Year. A good time to switch to a Roth IRA is usually when
you make less money. That’s because the tax cost of making the switch may be
more manageable.
●
Down Market Year. You can also convert when there is a drop in the
stock market. That’s because your IRA balance is temporarily lower, and you may
be able to convert the same investments at a lower tax cost and let any future
recovery happen inside the Roth. That growth can later come out tax-free if you
meet the Roth IRA guidelines.
What
to Consider Before Converting
The
potential tradeoff of converting is that you pay taxes now in exchange for more
tax flexibility in the future. Here are a few things to consider:
●
Tax Bracket: Current vs Future. If you anticipate being in a higher
tax bracket in the future, converting to a Roth is more attractive.
●
The Five-Year Rule. Roth IRAs have a general five-year rule for tax-free
qualified distributions. Every time you convert, it starts a new five-year
window in which you must wait to make withdrawals penalty-free if you are under
the age of 59½. If you convert to Roth frequently, it can create multiple
waiting periods to track.
●
Required Distributions. Unlike Traditional IRAs, Roth IRAs
don’t require you to take an annual distribution, required minimum
distributions (RMD). Traditional IRAs also require you to take annual
withdrawals starting at age 73; Roth does not. That’s what makes the Roth good
for long-term planning, tax planning, and building wealth.
●
Paying Taxes. Many people prefer to pay the conversion tax from cash
outside the IRA. Using IRA assets to cover the tax can reduce the amount that
stays invested, and if you are under 59½, it can also create extra penalties on
the amount withdrawn for taxes, per the IRS.
●
Irreversibility. Since 2018, Roth IRA conversions generally cannot be
recharacterized back into a traditional IRA. Once you convert, you usually
cannot undo it later, according to the IRS.
Benefits
of Conversion
A
Roth conversion may help you:
●
Lock in taxes at today’s rate rather than a potentially
higher future rate
●
Avoid required minimum distributions (RMD)
●
Tax-free withdrawal potential in retirement
●
Estate planning flexibility for heirs
●
Tax diversification (so that not all retirement income
depends on one tax treatment)
Downsides
of Roth Conversion
It
may not be the best move if:
●
You anticipate being in a lower bracket in the future
●
Conversion pushes you into a higher tax bracket
●
Extra income impacts Medicare premiums, tax credits, or
taxation of other income
●
You need the money earlier than retirement
●
Don’t have cash outside the IRA to pay the tax bill
Steps
to Consider
Before
converting, it helps to follow a simple process:
- Estimate how much of the
conversion will be taxable.
- Project whether that amount would move
you into a higher bracket.
- Decide if you should convert all at
once or in smaller pieces over several years.
- Make sure you have cash to cover the
taxes.
- Check on how soon you may need the
money, because of the five-year rules.
- Review your plan with a tax
professional. Is the conversion too big? Are you close to Medicare or
other income thresholds?
Bottom
Line on Roth Conversion
A
Roth conversion can be a savvy financial move, especially in lower-income years
or after a market drop. The best decision always depends on your individual tax
situation now, your expected tax bracket later, how long you leave the money
invested, and if you can pay the taxes now.
Do
One Thing:
Before converting your IRA into a Roth IRA, consider all the consequences
thoroughly.
*Information
in our blog posts are made available to you as self-help tools for your
independent use. We cannot and do not guarantee their accuracy, their
applicability to your circumstances or guarantee of credit. We encourage you to
seek personalized advice from qualified professionals regarding all personal
finance issues.