Are you considering converting your retirement fund to a Roth IRA account? The Roth IRA has become incredibly popular.
Roth IRA contributions are made from income that’s already been taxed. This means there is no immediate tax benefit. However, the money in your Roth will grow tax-free.
Roth IRAs do not require Minimum Distributions at 72, like traditional IRAs. You can let your money grow for as long as you want until you are ready to withdraw it.
You won’t be required to pay income tax on the money you withdraw from a Roth IRA. Remember that you already paid income tax before contributing?
Can you lose money in a Roth IRA?Can you lose money in a Roth IRA?
There are many other benefits to a Roth IRA. It’s not surprising that so many people convert their traditional IRA to a Roth IRA.
Is a Roth IRA Conversion a Good Idea? It is true that this type of conversion can be profitable over time. However, you must weigh the pros and cons.
When would you want to convert to a Roth IRA?
In some situations, converting an existing traditional IRA to a Roth IRA makes sense. The value of this investment strategy will ultimately depend on your individual situation, income, tax bracket and financial goals.
It is important to know that when you convert a retirement account into a Roth IRA you will be required to pay income tax on the converted amount.
Paying these taxes can be a good idea to avoid paying more tax later. However, this depends on how your current tax situation is and what it will look like in the future.
Converting to a Roth IRA is a good idea in the following scenarios:
- Your tax bracket will probably be higher than it is now. If you’re in a low tax bracket or expect to be one in the future, converting a traditional IRA into a Roth IRA may make sense. You can save money by paying tax on the converted funds while you are in a lower income tax bracket. Not sure of your future tax brackets? NewRetirement planner will help you estimate your future taxable income and expenses. This tool gives you the power to plan.
Taxes payable on lifetime income before converting to Roth
- Your losses can be used to offset your tax liability. If you convert another retirement account to a Roth IRA, then you will have pay income taxes for the amounts converted. It can make sense, then, to convert your Roth IRA in a tax year where you have losses that can offset the new tax bill.
- You do not want to start taking RMDs at 72. Converting to a Roth IRA may be a good option if you don’t wish to have to take RMDs. This account does not require RMDs to be taken at any age. You can use NewRetirement planner to assess your income requirements. You can check your income and expenses for each future year.
- Moving to a higher-tax state Let’s say you are moving from Tennessee, a no-tax state, to California. The state has income tax rates as high as 12.3%. In this case it might make sense to convert your other retirement accounts into a Roth IRA.
- Your heirs will benefit from a tax-free legacy. Converting to a Roth IRA is a good idea if you have extra retirement money and are concerned about tax liabilities. Vanguard says that “the people inheriting your Roth IRA must take annual RMDs but will not have to pay federal income tax on withdrawals if the account has been open for 5 years or more.”
There are many other situations where converting a retirement account to a Roth IRA can be logical. Before you make any drastic changes or start a conversion it is a good idea to consult a tax expert or financial advisor with expertise in tax.
You should at least model the conversion within a written retirement plan. NewRetirement planner allows you to test out conversion strategies within the context of your overall financial situation. The conversion will affect your cash flow, tax liability and net worth over the long term.
When would you not want to convert to Roth IRAs?
There are many situations where converting a Roth IRA is not advisable.A Roth IRA conversion can also be a costly waste of time in many personal situations. Here are some scenarios where a Roth IRA could be a waste of time.
- Your retirement income will be extremely low. A Roth IRA conversion might not make you more money. You can avoid paying higher taxes for the conversion by not converting your other retirement account into a Roth IRA. Instead, you will pay lower taxes in retirement on your income.
- There is not enough money to convert your retirement account into a Roth IRA. Since you will have to pay taxes on the converted funds, it’s a bad idea to do this in years where you don’t want to pay additional taxes.
- If you withdraw money from a Roth IRA, it must be held for five years. If you choose to withdraw the money within five years of the conversion, you will be charged a penalty.
These are only a few scenarios in which you should think twice before converting a retirement account into a Roth IRA. This move would not make sense in many other scenarios. You should consult a tax expert before making any decisions.
You can also make sure that you understand the projected income, savings, and expenses before converting. NewRetirement planner gives you detailed insights into your financial future.
Roth IRA Conversion Rules: What You Need to Know
Although there are limits on income that apply when contributing to a Roth IRA these limits do not apply for Roth IRA conversions. Here are some of the most important Roth IRA rules that you should know and understand.
What accounts can be converted?
You can convert any account to a Roth IRA. The most common conversion is from a traditional IRA. You can convert any funds from a QRP account that are eligible for a rollover to a Roth IRA.
Rollover 60 days rule
If you want to roll over the money from your traditional IRA, you can do it in 60 days after the distribution. You must do this within 60 days of receiving the funds. If not, the amount (less the non-deductible contributions), will be taxed in the year it is received. The conversion will also not occur, and you will face the IRS 10% early withdrawal tax penalty.
Trustee-to-Trustee Transfer Rule
It is the easiest and fastest way to transfer funds. You also eliminate the risk that your traditional IRA will be taxed. The money will be transferred to your Roth IRA by your traditional IRA trustee.
Transfer of the same Trustee
It is easier to do this than a trustee-to -trustee transaction because the money remains within the same institution. Set up a Roth IRA with the trustee that holds your traditional IRA and instruct them to transfer the money out of the traditional IRA.
Other Details You Should Know
If you do not follow the above rules and you don’t deposit your money into a Roth IRA within 60 days you may be subject to a penalty of 10% on early distributions, as well as income tax on the converted amount if you are under the age 59 1/2.
You will have to pay income tax on the converted amount regardless of what rule you follow. When you file your taxes for the year in which the conversion occurred, you’ll need to report the conversion on Form 8606.
What is the Backdoor Roth IRA?
The Backdoor Roth IRA is a possible workaround if your income is too large to contribute directly to a Roth IRA. The Backdoor Roth IRA allows consumers to invest first in a traditional IRA, which does not have income restrictions. Then, a Roth IRA is converted, allowing high-income investors to take advantage of future tax-free distributions and growth without paying income taxes.
Backdoor Roth IRAs can be a good option in situations where converting to a Roth IRA makes sense. This investment strategy is designed to save you money on taxes in the future at the expense of paying higher taxes today, the year of the conversion.
Backdoor Roth IRAs have a huge tax bill. You’re hoping that you can lower your future tax liability. This is a noble objective, but the Backdoor Roth IRA can only be used in cases where real tax savings are possible.
Modeling IRAs into Your Own Plan
Are you interested in a Roth IRA but not sure if it’s right for you or not? You can try to model it on your own plan.
NewRetirement Planner has the most comprehensive and powerful modeling tool online. This tool is for those who are looking to make informed decisions about their future financial security. The tool allows users to create, manage, and design personalized paths towards a secure financial future. The tool’s core purpose is to help you make informed decisions about your finances, such as whether you should convert to a Roth.
NewRetirement planner offers two ways to model conversions:
Model Individual Conversions
After you have created your plan, you can model a conversion you believe would be beneficial.
- Money Flows allows you to specify the account where the money is to be withdrawn from, the amount to be converted, the age at which you want the conversion to take place, and the projected return rate on the money you convert.
- You can see immediately if you have changed your age of retirement, the value of your estate, or if you are liable for lifetime taxes.
- You can also review charts that will help you determine your tax liability for the year of conversion, as well as the impact on your income from RMDs.
Lifetime tax after performing Roth conversions
Roth Conversion Explorer
The Roth Conversion Explorer can be found within NewRetirement Planner.This tool can help you decide if and when you should convert to Roth. This tool will analyze your entire plan and run hundreds of scenarios to create a conversion strategy which could increase the value of your estate at your longevity.
The deadline to convert a Roth IRA
The deadline to convert funds from a Traditional IRA into a Roth IRA depends on the deadline for filing taxes for the year that the conversion was made. This is usually April 15th the year following. If you convert in 2022, your deadline to report the conversion would be April 15, 2023.
It’s important to remember that a Roth conversion has a deadline, and it is the 15th October of the following year. If you convert a traditional IRA into a Roth IRA, you have until the 15th of October, 20223 to undo that conversion.