Roth IRA Conversion

A Roth conversion entails transferring your funds from a Traditional IRA or taking a qualified distribution from your employer-sponsored retirement plan, like a 401(k), 403(b), or governmental 457(b), and moving them into a Roth IRA.

The rationale behind a Roth IRA conversion centers on tax savings. When you pay taxes on the funds you transfer to your Roth account today, you’re essentially wagering that your current tax bracket is lower than what you’ll face in the future. This strategic conversion not only reduces your tax liability but also yields greater long-term savings as you increase the amount you convert.

Roth IRA conversions are used to minimize tax obligations in retirement. While funds in a traditional IRA or 401(k) are taxed as ordinary income when withdrawn, funds in a Roth IRA are not. This is because Roth IRAs are funded using after-tax dollars.

Converting funds into a Roth IRA incurs income tax for the year of the conversion. However, this trade-off grants you tax-free income during your retirement years. Furthermore, your heirs will inherit the privilege of tax-free access to the converted funds upon your passing.

Before proceeding with a Roth IRA conversion, it’s advisable to consult with a tax advisor. They can provide valuable insights into the present and future tax implications of your choice and assist you in evaluating whether conversion aligns with your specific financial goals and requirements.

There are pros and cons to a Roth IRA conversion. Consider both when making your decision.

Anyone who wants to start a Roth IRA conversion can do it, but you must have both types of individual retirement accounts — a traditional IRA account and a Roth IRA account. You can open either at almost any financial institution. After setting up your Roth account, reach out to the administrators of your IRA or 401(k) and specify the amount you wish to transfer to your new account.

When tax season arrives, it’s essential to complete Form 8606, which serves to inform the IRS about your Roth IRA conversion. Be sure to account for the conversion taxes when filing your annual tax return for that year.

If you execute a Roth IRA conversion before reaching the age of 59 1/2, you’ll initiate a five-year waiting period. Within this waiting period, any withdrawals of converted funds may incur a 10% early withdrawal penalty, even if you are older than 59 1/2 when you make the withdrawal.

There are three common types of Roth IRA conversions: traditional IRA to Roth IRA, 401(k) to Roth IRA and backdoor Roth IRA conversions. To determine which one aligns best with your financial goals, it’s advisable to consult with your financial advisor.

There are many ways a Roth IRA conversion can play out depending on your circumstances. It’s important to understand the consequences of starting a conversion, particularly regarding tax implications.

Suppose you earn $60,000 a year and want to convert $30,000 in either a traditional IRA or a 401(k) to a Roth IRA. In 2023, your income puts you in the 22% federal tax bracket. If you go through with the conversion, you’ll pay $6,600 in federal taxes (State taxes may add more to your tax bill).

Taxes on the same Roth IRA conversions can be higher for those who have higher incomes. Higher incomes can result in more substantial tax liabilities during the conversion process because the conversion amount is considered to be ordinary income at the highest applicable tax bracket for the filer. For example, someone who makes $200,000 a year and wants to convert that same $30,000 using a backdoor Roth IRA conversion would pay $9,600 in federal taxes on that money.

When contemplating the conversion of one or more of your retirement accounts to a Roth IRA, it’s essential to familiarize yourself with a few key rules.

Always consult your financial advisor before proceeding with a Roth IRA conversion. They will offer guidance tailored to your needs and circumstances, explaining the tax implications and ensuring your compliance with all rules and regulations.

When deciding whether to initiate a Roth IRA conversion, you have several factors to consider. These include tax implications, your retirement objectives, your current financial situation and the anticipated timing of your need for the funds.

You cannot reverse a conversion outside of the recharacterization period, so it’s important to carefully weigh this decision. Consulting with a financial advisor will help you understand the process.

In some cases, starting a Roth IRA conversion is a smart financial move.

However, there are some circumstances in which a Roth IRA conversion won’t help you.