A Roth IRA conversion is a proactive financial move that can save you thousands in lifetime taxes and substantially increase legacy value to heirs. This article outlines the benefits of Roth IRA conversions, accounts that are eligible to be converted, and key considerations for suitability and the optimal time to convert.
What Is a Roth IRA Conversion?
A Roth IRA conversion involves transferring funds from a tax-deferred retirement account, such as a traditional IRA, into a Roth IRA. The converted amount is considered taxable income in the year of the conversion, but once in the Roth IRA, your money grows tax-free and can be withdrawn tax-free in retirement. The following are examples of retirement accounts that are eligible for Roth IRA conversion:
Traditional IRA and Traditional 401(k)
403(b)
SEP IRA
SIMPLE IRA
Solo 401(k)
Key Benefits of Roth IRA Conversions
1. Tax-Free Growth and Withdrawals:
Unlike tax-deferred retirement accounts, only post-tax dollars can be contributed to a Roth IRA. The primary appeal of a Roth IRA its entirely tax-free appreciation and retirement withdrawals. Strategic execution of a conversion can enhance the long-term growth of your wealth, lead to more income to spend in your retirement years, and leave more wealth remaining to pass along to your children.
2. No Required Minimum Distributions (RMDs)
Unlike traditional IRAs, Roth IRAs are not subject to required minimum distributions during your lifetime. This allows your account to continue growing tax-free for a longer period and provides greater flexibility in retirement income planning.
3. Estate Planning Advantages
Since Roth IRAs are not subject to RMDs, the account can be preserved and passed down to your children. Beneficiaries will eventually have to take distributions, but they can do so tax-free over a 10-year period under current IRS rules, potentially extending the tax-free growth period. Roth IRA assets also avoid the dreaded “double tax” Income in Respect of a Decedent for your heirs.
Strategic Considerations for Roth IRA Conversions
Due to the immediate tax consequences, Roth IRA conversions must be approached with thoughtful planning and execution to optimize the benefits.
Convert During Low-Income Years: The ideal time to do a Roth conversion is when your taxable income, and thus your tax rate, is temporarily lower. This could occur during a sabbatical, early retirement before claiming Social Security or pensions, or after a job loss. Converting during a lower-income year reduces the overall tax burden and maximizes long-term growth of your wealth.
Be Mindful of Market Conditions: If the value of your tax-deferred retirement account is temporarily lower due to a stock market slump, the taxes you will owe upon converting will be less than if you convert after a period of strong stock market performance.
Partial Conversions Over Time: Instead of converting your full account in a single year, the optimal approach is often times to convert smaller amounts over several years. This strategy helps avoid bumping you into a higher tax bracket that could also trigger higher Medicare premiums.
Coordinate with Tax Brackets: Being mindful of federal income tax brackets allows you to convert just enough to "fill up" a lower bracket. For example, if you’re in the 22% tax bracket and have room before hitting the 24% bracket, you can convert an amount up to that income threshold to minimize taxes.
Pay Taxes with Outside Funds: To get the most out of a Roth conversion, it’s best to pay the taxes from funds outside the IRA. Using IRA funds to pay the tax bill reduces the amount converted and diminishes the compounding benefit of the Roth account.
Married Filing Joint vs. Married Filing Separate: If you are married to a high-earning spouse and you retire before your spouse, filing your taxes separately during the years you convert may put you in a lower tax bracket than filing jointly and result in less immediate tax burden from the conversion.
Will You Need the Money in 5 Years or Less?: There's a 5-year holding period on withdrawals of money that was part of a Roth conversion. If you think you'll need the money within 5 years of converting, you should consider converting only the amount that you will not need in the following 5 years.
Final Thoughts
Roth IRA conversions are not a one-size-fits-all solution, but when timed and executed properly, they can unlock substantial tax-free retirement income and wealth creation. Whether you're in the early stages of your career or approaching retirement, it’s wise to consult with a financial advisor to determine if a Roth conversion aligns with your broader retirement and tax planning strategies.
Contact us at clientservice@riseinvestmentsusa.com to receive a complimentary and customized analysis of whether a Roth IRA conversion strategy could be beneficial for you.
Disclosure
RISE Investment Management, LLC ("RISE" or "RISE Investments") is an investment adviser registered under the Investment Advisers Act of 1940. Registration of an investment adviser does not imply any level of skill or training. This publication is solely for informational purposes and past performance is not indicative of future results. Any description of products, services, and performance results of RISE contained in this publication are not an offering or a solicitation of any kind. No advice may be rendered by RISE Investments unless a client service agreement is in place. Advisory services are only offered to clients or prospective clients where RISE Investments and its representatives are properly licensed or exempt from licensure. All of the information in this publication is believed to be accurate and correct as the date set forth. RISE does not have or accept responsibility or an obligation to update such information. Please note, this article is for education purposes and should not be treated as tax or legal advice. This article is not a substitute for legal or tax advice from your professional legal or tax advisor.