Converting Your Roth IRA:

Converting Your Roth IRA: Contributions to a Roth IRA are made with pre-tax income, so there is no immediate tax benefit, but the money in a Roth grows tax-free over time.

Roth IRAs, unlike traditional IRAs, do not require required minimum distributions (RMDs) at the age of 72, so you can keep your money growing until you’re ready to access it.

When you take distributions from a Roth IRA, you will not have to pay income taxes on the money. Remember how you already paid income taxes before you contributed?

When Would You Like to Convert Your IRA to a Roth IRA?

Converting an existing traditional IRA or another retirement account to a Roth IRA can make sense in a variety of circumstances, but not always. At the end of the day, the value of this investing strategy determines by your specific situation, income, tax bracket, and the financial goal you’re attempting to achieve in the first place.

The most important point to remember is that when you convert another retirement account to a Roth IRA, you must pay income taxes on the amounts converted.

You’ll almost certainly be in a higher tax bracket than you are now. Converting a traditional IRA to a Roth IRA can make sense if you are in an especially low tax bracket this year or simply expect to be in a much higher tax bracket in retirement. By paying taxes on the converted funds now, while you’re in a lower tax bracket, you can avoid paying income taxes at a higher tax rate when you retire and begin taking distributions from your Roth IRA.

You don’t want to start taking distributions when you’re 72. Converting to a Roth IRA can also make sense if you don’t want to be forced to take RMDs from your account at the age of 72. RMDs are not required on this type of account at any age. (You can use the NewRetirement Planner to help you determine your income requirements.) Examine your taxable income for each subsequent year and determine whether you require the income to cover expenses.)
You’re relocating to a state where income taxes are higher. Consider moving from Tennessee — a state with no income taxes — to California — a state with income taxes as high as 12.3%. In this case.

You have financial losses that can use to offset the conversion’s tax liability. When you convert another retirement account into a Roth IRA, you must pay income taxes on the converted amounts. Given this, it may make sense to work on a Roth IRA conversion during a year in which you have specific losses that can be used to offset your new tax liability.

You want to leave your heirs a tax-free inheritance. Converting to a Roth IRA may make sense if you have extra retirement funds and are concernes about your heirs incurring tax liability on an inheritance. “The people who inherit your Roth IRA will have to take annual RMDs, but they will not have to pay any federal income tax on their withdrawals as long as the account has been open for at least 5 years,” according to Vanguard.

When Would You Prefer Not to Convert?

Given that a Roth IRA conversion has immediate tax consequences, there are numerous scenarios in which it does not make sense.

There are also numerous personal situations in which a Roth IRA conversion would be detrimental to a person’s long-term goals. Here are some scenarios in which converting to a Roth IRA could be a costly waste of time.

In retirement, your income will be extremely low. If you believe you will be in a much lower income tax bracket in retirement, a Roth IRA conversion may not benefit you. By not converting another retirement account to a Roth IRA, you can avoid paying taxes on the conversion now at a higher rate and instead pay income taxes at a lower rate on your distributions in retirement.
You don’t have any spare cash for the conversion. Because converting another retirement account to a Roth IRA necessitates paying income taxes on the converted funds now, this move is unwise in years when you don’t have extra money to pay more taxes.

You might require the funds sooner rather than later. Withdrawals from a Roth IRA conversion account are subject to a five-year hold period. This means that if you chose to take distributions within five years of the conversion, you would have to pay a penalty.

You Should Understand the Roth IRA Conversion Rules

Though there are income limits for Roth IRA contributions, these income limits do not apply to Roth IRA conversions. With that in mind, here are some crucial Roth IRA conversion rules you should know

Rollover Period of 60 Days

You can take direct delivery of your traditional IRA funds (a check made payable to you personally) and then roll them over into a Roth IRA account, but you must do so within 60 days of the distribution. If you do not, the distribution amount (less non-deductible contributions) will be taxable in the year received, the conversion will not occur, and the IRS 10% early distribution tax penalty will apply.

Transfer of the Same Trustee

Because the funds remain within the same institution, this is even simpler than a trustee-to-trustee transfer. Simply open a Roth IRA account with the trustee who holds your traditional IRA and instruct them to transfer funds from the traditional IRA to your Roth IRA account.

Rule of Trustee-to-Trustee Transfer

This is not only the simplest way to complete the transfer, but it also virtually eliminates the possibility of your traditional IRA funds becoming taxable. Simply instruct your traditional IRA trustee to transfer the funds to the trustee of your Roth IRA account, and the transaction should go smoothly.

Transfer of the Same Trustee

What Exactly Is a Backdoor Roth IRA and How Does It Work?

If your income is too high to contribute directly to a Roth IRA, the Backdoor Roth IRA may be a viable option. This strategy recommends that consumers first invest in a traditional IRA because these accounts do not have income restrictions on who can contribute. Following that, a Roth IRA conversion occurs, allowing high-income investors to benefit from tax-free growth and future distributions without having to pay income taxes later on.

Individual Conversions Model

You can specify the account from which the money will be withdrawn, the amount you want to convert, the age at which you want to convert, and your projected rate of return on the converted money in Money Flow.
Once you’ve saved, you’ll be able to see right away if the conversion changed your out-of-savings age, estate value, or lifetime tax liability.
You can also review charts to determine your tax liability in the year you convert, the impact of RMDs on income, and more.

Make use of the Roth Conversion Explorer

Within the NewRetirement Planner, there is a modeling tool called the Roth Conversion Explorer.

Converting an IRA to a Roth IRA

If you believe a Roth IRA conversion is a good investment for you, here are the steps you should take.

Create a Roth IRA

To begin, open a Roth IRA with one of the top brokerage firms. Because you pay $0 per trade and $0 per year, we believe TD Ameritrade is one of the best Roth IRA providers available. You should also look into top Roth IRA providers such as Betterment, Ally, LendingClub, and Vanguard.

Convert Existing IRA Assets to a Roth IRA

Following that, you should initiate a Roth IRA conversion with your traditional IRA or QPR provider. Remember that if you accept the funds in the form of a check, you have 60 days to deposit the funds into your Roth IRA account. You can also have the funds transferred via a trustee-to-trustee transfer or even using the same brokerage account, which is often easier because the transfer should be handled on your behalf.

Conversion Income Taxes Must Be Paid

The main disadvantage of a Roth conversion is that you will have to pay taxes on the amount converted in the current year, which could be significant depending on your income tax bracket and the amount you’re converting. That being said, you should plan your conversion for a year when you are in a lower tax bracket or have other losses that can be used to offset the additional taxes caused by the conversion.

FAQ

What are the disadvantages of Roth conversion?

The primary disadvantage of converting to a Roth IRA is paying income tax at the time of conversion, which could be significant. If you expect to have a lower tax rate in the future, converting to a Roth IRA may not provide any tax benefits.

Are Roth conversions on their way out in 2022?

Pre-tax IRA conversions would still be permitted until 2032, but taxes would level at the time of conversion. Mega backdoor Roth conversions, which allow individuals to transfer up to $38,500 from qualified 401(k) plans to a Roth IRA, would be phased out beginning in January 2022.

How do I know if my Roth conversion is a good idea?

When the market falls, consider converting to a Roth IRA.

This is due to the fact that you take on the market value of your conversion. If your $50,000 investment falls to $40,000, you will only be taxed on the difference. When the markets recover, you will no longer have to pay taxes on your subsequent investment gains.

Should you convert your Roth IRA after the age of 62?

Converting a regular IRA to a Roth IRA after the age of 60 can help taxpayers who anticipate a higher tax rate after retirement lower their total tax burden over time. Roth IRA conversions allow earnings to grow tax-free while eliminating the need for require withdrawals, which raise post-retirement tax costs.

When does a Roth IRA no longer make sense?

Unlike traditional IRAs, which do not allow contributions after the age of 7012, you can open a Roth IRA at any age. The IRS is fine with you opening and funding a Roth as long as you’re still drawing earned income and breathing.

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