Roth IRA Conversions
You may have heard the term thrown around in the office or in your favorite financial publication, but do you know what it is or whether it’s something you should be doing? Let’s break it down.
Before we begin, if you’re unfamiliar with the difference between a Traditional IRA and a Roth IRA be sure to check out this article explaining the differences before moving forward.
So, what is a Roth conversion?
Simply put, it’s taking funds from your Traditional IRA or Qualified employer-sponsored Retirement Plan (QRP) and moving them to a Roth IRA. You are choosing to realize that income and pay taxes on it now rather than waiting until some later date in retirement.
Why in the world would I want to pay taxes now when I can wait and pay them later?
I know. I hear you. I’m not jumping at the opportunity to give Uncle Sam any more now than I have to either, but there are several reasons it can make sense. All these reasons boil down to this – whether it’s today, tomorrow, or 30 years from now, pay the lowest tax rate on your income that you can. Roth conversions give us the ability to pay taxes tactically. We can choose the most opportune years to realize certain income rather than waiting to see how the tax chips fall. Let’s look at an example.
Greg and Grace live in Greenville, SC. Greg is a semi-retired engineer who enjoys working the gate at the Greenville Drive baseball games, and Grace just moved from full to part-time work for the Greenville County School District. They have saved sizeable balances in their 401k and 403b plans. In a few years, their annual income will increase due to the large Required Minimum Distributions (RMD) from their retirement accounts in addition to Grace’s pension from PEBA. While they’re pleased to have a solid retirement income, they’re not looking forward to paying taxes on all their savings. Is there anything they can do to have more control over their income and potentially reduce their overall tax burden? Yes! For the next several years, while they have less income from reduced work, they should consider converting some of their retirement accounts to a Roth and lock in a lower tax rate on those funds.
I’m not semi-retired or retired. Does that mean I don’t need to worry about Roth conversions?
Absolutely not. Roth conversions can make sense for people in many different stations in life – young professionals all the way to long-time retirees. If you have pre-tax retirement savings, then we recommend sitting down with your financial advisor or tax professional to discuss whether converting any of those funds to a Roth account makes sense in your particular situation.
A word of caution, though.
We have often heard investors (and even some advisors!) claim they should do a Roth conversion simply because they are currently in a low tax bracket. While this may be true in many circumstances, taxes are not always straightforward and simple. It is important to go through a thorough tax analysis to understand the potential ramifications of adding income to your tax year. If your advisor is not a CPA, they should be using some sort of tax planning software, such as Holistiplan, to make sure you do not inadvertently pay more in taxes or disqualify yourself from certain tax benefits (e.g., raising your Medicare premiums or losing education credits).
Roth conversions can be a powerful tool for keeping more money in your pocket, but they must be planned carefully. If you have further questions or are wondering if a Roth conversion makes sense for you, feel free to reach out to us. We have advisors with the proper tools and resources to help you make a prudent decision.
Provista Wealth Advisors in Greenville, SC, provides peace of mind through personalized asset management, expert estate planning, and retirement planning. Navigate your financial journey with confidence. Rest Assured, We Have A Plan. Give us a call at (864) 696-2410 or send us a message to schedule your free introduction meeting.