Most of us know there are two types of IRAs: Traditional and Roth. You may even know that there are tax differences between the two, and it’s possible you have both of these savings vehicles in your retirement arsenal. But what you may not know is that your traditional IRA can be converted to a Roth IRA. If you’re drawn to the benefits of a Roth and think that it would be more favorable for your financial situation, here’s what you need to know about a Roth conversion.
Before you can evaluate whether a conversion is in your benefit, you need to understand what sets these two types of savings accounts apart. Here’s a short primer for you: Traditional IRAs allow you to save on taxes now and pay them at a later date when your income is traditionally lower. Roth IRAs are funded with after-tax money, and withdrawals in retirement are tax-free.
Aside from the primary tax difference between the two, Roths have income restrictions whereas traditional IRAs don’t. In 2019, a single person making above $137,000 cannot contribute to a Roth, and if they make over $122,000, the amount they can contribute begins to phase out. For a married couple filing jointly, the phaseout range is $193,000-$203,000.
Why Should You Convert Your IRA?
There are many reasons why you may want to consider a Roth conversion. For one, there are no income limitations when you convert. If you are not eligible for a Roth initially, you can pay the taxes to convert your Traditional IRA to a Roth and still reap the benefits. In addition to tax-free growth, Roth IRAs are great because they don’t require you to start taking distributions when you’re 70½ like all the other retirement plans out there. In fact, instead of taking money out, you can keep putting money in. Also, they have favorable rules for your heirs, so your account can keep growing tax-free for years after you are gone.
Also, when you convert your IRA, you pay taxes now so that you don’t have to when you make withdrawals in the future. Roths also have more flexible withdrawal rules, which is an attractive feature to many. Finally, if you have a substantial IRA, you can reduce the amount of your RMDs by converting a portion of it to a Roth, keeping you in a lower tax bracket when it comes time to start taking withdrawals.
So the big question is, when should you convert your IRA? Is there an ideal time to pay the taxes and make the change?
When Should I Convert My IRA?
There are many scenarios to consider when deciding when you should convert your IRA. The most important factor to consider is your current tax bracket. If you find yourself in a lower tax bracket due to unemployment, medical expenses, business loss, or significant tax credits, it would be worth it to convert now. If you expect your income and tax rate to increase in the years to come, now would be the ideal time to make the change.
Make sure you have the resources available to pay those extra taxes on the withdrawal. If the only extra money you have is from the IRA account itself, you are cheating yourself out of the chance for those funds to grow and compound tax-free in the Roth.
Remember that the amount withdrawn from the Traditional IRA counts toward your annual income, so know your numbers and don’t let the conversion push you into a higher tax bracket for the year.
How It Works
The basic process to convert your IRA: withdraw the amount you’d like to invest in a Roth, pay the tax owed on the distribution, then reinvest it into a Roth account.
Keep in mind that there are many complex factors involved in the conversion process.
If you are already taking RMDs, you must take it first and then convert the remainder. Conversions are not an all-or-nothing decision and have no minimum amount requirement, so you can convert as little or as much of your IRA as you’d like.
Is A Roth Conversion Right For You?
A Roth conversion is an advantageous way for high-income earners and traditional IRA account earners to access the benefits of a Roth IRA. However, because of the many tax implications, you need to be careful. It’s important to work with an experienced financial professional to ensure you are making the most of your investments and not paying more taxes than necessary.
If you’re ready to weigh your options, I can help you determine if a Roth conversion is a good fit for you and strategize proper implementation. Call my office at (949) 221-8105 x 2128, or email me at [email protected] to set up an appointment to get started!
About Mike Loo
Mike Loo is an independent financial advisor with more than 20 years of experience in the financial services industry. His mission is to make a meaningful impact on the lives of clients and the people they care most about, help them make educated decisions with their money, and build a strong financial foundation for both themselves and their next generation. Mike is committed to meeting a high standard of excellence, taking the time to listen to clients’ needs, and designing strategies that aim to help clients save money and reduce debt. He seeks to fit a client’s investments into their life and educate them so they’ll understand their investments. To learn more about how Mike may be able to help, connect with him on LinkedIn, call his office at (949) 221-8105 x 2128, or email him at [email protected].
Mike Loo is a registered representative for LPL Financial (LPL) and an Investment Advisor Representative (IAR) for Trilogy Capital (TC). Securities offered through LPL, Member FINRA/SIPC. Investment advisory services offered through TC, a Registered Investment Advisor. TC markets advisory services under the name of Trilogy Financial (TF), an affiliated but separate legal entity. TC and TF are separate entities from LPL.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.
Traditional IRA account owners should consider the tax ramifications, age and income restrictions in regards to executing a conversion from a Traditional IRA to a Roth IRA. The converted amount is generally subject to income taxation.