Are you planning for retirement? No matter your age or life stage, one of the best options is to fund a Roth IRA, which allows for tax-free growth and the ability to leave tax-free money to heirs, among other benefits.

What happens if you have another retirement plan, for example, a traditional IRA – or money in an old 401k? No problem! In our opinion, there are many strong reasons to convert some of your “pre-tax” retirement accounts to a Roth IRA. 

How can you make this happen? We have the full rundown of how you can use a Roth IRA conversion to set up tax-free income for your retirement planning. 

First:  What is a Roth IRA?

A Roth IRA is a special account where you can save for retirement with tax advantages. With a Roth IRA, you deposit your money after taxes and can then invest the money in a variety of ways. You can invest in a Roth IRA no matter your age, so long as you earned enough income to cover the contribution. Once you reach retirement, however, you can withdraw the money tax-free (59 and ½ years). The tax-free withdrawals are one of the biggest perks! 

Roth IRAs have a number of other great benefits, too: 

• In a Roth IRA, you will have no required minimum distributions (RMDs)
• You can withdraw contributions at any time without penalty 
• The Roth IRA is also an Estate Planning tool, as you can pass down a Roth IRA to your heirs, who will receive significant tax advantages, too. 

What are Roth IRA conversions…and why NOW?

Roth IRA conversions involve transferring retirement funds from a traditional IRA or 401k into a Roth IRA account. And there are a number of benefits to converting! Here’s why:

• We are currently in the lowest tax environment since the 1940s and taxes should continue to remain low for the time being
• Tax reform in 2017 reduced marginal tax brackets for nearly all Americans, but that benefit will expire in 2026 (unless Congress acts). That means that by 2026, people in the 12% bracket will go back to 15%, and 22% back to 25%, and so on. 
• COVID-19 related stimulus bills cost upwards of $5.3 TRILLION over the last 18 months…and it i likely taxes will need to move upward to make up for the current and future deficit 
• Those who work hard, plan ahead, save well and invest accordingly may find they will have surprisingly high taxable income in retirement…and potentially higher tax brackets than they face today!
• There is no guarantee the Roth Conversion remains an option in years to come

If you’re approaching retirement, it may be in your best interest to act now, considering taxes may increase down the line. Contributions and conversions to this type of account will go into after taxes and, in turn, grow tax-free forever.

What are the benefits of Roth IRA conversions?

With a strategic conversion plan, you can convert money from a pre-tax plan (like a traditional IRA, or pre-tax 401k). That conversion will trigger a taxable event. What does that mean? If you convert $100,000 from your pre-tax 401k to your Roth IRA, you will add $100,000 of income to your tax return that year. 

Okay, okay, so hearing that makes you cringe just thinking of the tax bill. It’s a short-term tax burden, of course, but the long-term gains about having your money grow tax-free. 

A Roth IRA conversion will work best for you if you have the following characteristics:

• If you are seeking a tax-free income stream in retirement (or after age 59 ½)
• If you are in the early years of retirement or are semi-retired
• If you are in the 22% tax bracket or lower:
  • Less than $85K if taxable income if single
  • Less than $170K in taxable income if married
• When you pass, you want to leave your heirs tax-free assets

How do you convert to a Roth IRA?

Converting a 401k or traditional Roth IRA to a Roth IRA is relatively easy, and only takes a few weeks to complete. Follow these easy steps: 

• Open a Roth IRA account: Open your Roth IRA account at your preferred financial institution.  Need a Roth IRA Account?  We are happy to help!

• Contact plan administrators: You need to reach out to your old and your new financial institutions and see what you need to make the conversion happen. Make sure to fill out which assets will be converted

• Submit the paperwork: Fill out your paperwork and turn it in before mid-December 

• Notify your accountant or submit the 8606 form when filing taxes this year to notify the IRS of the conversion

We highly recommend working with a financial professional if you’re considering a Roth IRA conversion. We can help you decide whether a conversion is right for you, and guide you through the process if needed.  

Don’t forget…

Before you convert your money to the Roth IRA, you should keep in mind a few things:

• Budget for taxes!  If you are able – consider paying the taxes due on the Roth Conversion out of savings
• The five year rule: Dollars converted to your Roth IRA account must be in the account for five years to avoid penalties and taxes
• Age limits: If you convert after the age of 72, the RMD must come out before the conversion (RMDs will not be eligible for Roth conversions)
• It may make more sense to convert over a few years time
• A conversion may affect any government programs you participate in as the funds that come out of a Traditional IRA or 401k are counted as taxable income

If this seems overly complex or confusing, don’t worry — that’s why we’re here! We’ll help you think through all the fine print and possible options. 

The message here is that the time for a Roth Conversion is NOW given a favorable tax environment, potentially higher tax rates in coming years and current lenient rules regarding the Roth Conversion.  Contact us today and we’ll help you assess how Roth conversions fit into your overall retirement plan.