By Matt Cherry, CFP®
When it comes to planning for retirement, the decisions you make today can have a big impact on your financial future. One strategy gaining popularity among investors is the Roth conversion.
In this article, we break down everything you need to know about Roth conversions:
- What a Roth conversion is and how it works
- Potential Roth conversion benefits
- Could it be the right move for you?
What Is a Roth Conversion?
Simply put, a Roth conversion involves transferring funds from a traditional retirement account, like a traditional IRA or 401(k), into a Roth IRA. The main difference? Contributions to traditional accounts are often made with pre-tax dollars, meaning you pay taxes later when you withdraw. Roth IRAs, on the other hand, are funded with after-tax dollars, but qualified withdrawals are tax-free.
By converting funds into a Roth IRA, you pay taxes on the amount converted in the year of the conversion, but future earnings and withdrawals can grow tax-free, if certain conditions are met.
Why Consider a Roth Conversion?
You might be wondering: Why would anyone want to pay taxes now instead of later? Here are a few reasons why a Roth conversion can be a smart move for many investors:
- Tax Diversification: Having a mix of traditional and Roth accounts gives you more flexibility in retirement. You can choose to withdraw from accounts that reduce your tax liability year-to-year.
- Potential for Tax-Free Growth: Once funds are in a Roth IRA, they grow tax-free. This can be especially valuable if you expect to be in a higher tax bracket in the future.
- No Required Minimum Distributions (RMDs): Unlike traditional IRAs, Roth IRAs don’t have RMDs during your lifetime, which means your money can keep growing without mandatory withdrawals.
- Estate Planning Benefits: Roth IRAs can be passed to heirs tax-free, which can help preserve your legacy.
Who Might Benefit From a Roth Conversion?
A Roth conversion might not be the perfect fit for everyone, but for many, it can open up some real advantages. If you think your tax rate could be higher in retirement than it is now, it’s definitely worth considering. Having some extra money outside your retirement accounts to cover the taxes on the conversion can make the process a lot smoother and less stressful.
It’s also a smart way to reduce the required minimum distributions you’ll face later, giving you more control over your taxable income when you retire. And if leaving a legacy to your loved ones is important to you, Roth conversion benefits include potentially lessening their future tax burden, making it a thoughtful move for your family’s financial future.
Important Things to Consider
While the Roth conversion benefits are compelling, there are important factors to consider before moving forward. One of the biggest considerations is the tax impact. When you convert funds from a traditional IRA or 401(k) to a Roth IRA, you’ll owe income taxes on the converted amount in that tax year. This can lead to a significantly higher tax bill if you convert a large sum all at once. Timing your conversion during a year when your income is lower can help reduce this tax burden (many people choose to do partial conversions over several years to spread out the tax hit and manage their tax brackets more effectively).
Additionally, it’s important to be aware of the five-year rule, which requires your Roth IRA account to be open for at least five years before you can make qualified, tax-free withdrawals. This rule applies both to your original contributions and any converted amounts.
Finally, large conversions can sometimes increase your reported income enough to affect Medicare premiums or other income-based benefits, so it’s essential to consider these potential impacts when planning your strategy.
Steps to Start Taking Advantage of Roth Conversion Benefits
If you think a Roth conversion might be right for you, here are a few steps to take:
- Review your current retirement accounts: Identify which accounts are eligible for conversion.
- Estimate your tax impact: Calculate how much tax you’ll owe if you convert now.
- Consider your cash flow: Determine if you have funds outside your retirement accounts to cover the tax bill.
- Plan the timing: Decide if it makes sense to convert all at once or spread it over several years.
- Consult a financial advisor: Work with a professional to create a personalized Roth conversion plan that fits your goals.
Could a Roth IRA Conversion Be Right for You?
Roth conversions offer a powerful way to build tax-efficient retirement income and leave a lasting legacy. While the idea of paying taxes now can feel daunting, the long-term Roth conversion benefits often outweigh the up-front costs, especially when done thoughtfully.
If you’d like to learn more about Roth conversion benefits and whether this strategy aligns with your financial plan, don’t hesitate to reach out to the team at ABLE Financial Group. We’re here to guide you every step of the way toward a more confident and less-taxing retirement.
To learn more about our team and the ways we can help guide you, call 480.258.6104 or email adam@ablefinancialgroup.com today.
About Matt
Matt Cherry, CFP®, is a financial advisor at ABLE Financial Group, a financial services practice that focuses on transition planning and simplifying the complexities of their clients’ wealth. Matt is a distinguished professional with a Magna Cum Laude degree in finance from the WP Carey School of Business at Arizona State University. He is also a CERTIFIED FINANCIAL PLANNER®, CFP®, showcasing his dedication to excellence. After starting his career at Charles Schwab and working with an independent firm for a few years, Matt joined ABLE Financial Group in January 2021. At ABLE Financial Group, he specializes in Social Security planning and played a key role in implementing the industry-leading planning software, eMoney.
Passionate about giving back, Matt has been a Big Brother with Valley Big Brothers and Big Sisters, fostering mentorship and support. He volunteers with various organizations in the Valley and sits on the Professional Advisory Council for the Southwest Autism Research and Resource Center (SARRC).
An avid cyclist, Matt completed the challenging “America’s Most Beautiful Bike Ride” twice, riding 100 miles around Lake Tahoe to raise funds for the Leukemia and Lymphoma Society. A severe back injury in 2017 led to surgery and a shift in his cycling path. However, this adversity introduced a new passion – YOGA. Matt’s daily yoga practice has become a cornerstone of his life, contributing not only to his physical well-being but also playing a crucial role in his recovery and ability to walk.
Outside the office, Matt revolves around his two delightful daughters, Emma & Lyla. Being an Arizona native, family time often involves exploring the state and enjoying weekends on the beach in Mexico for rest and relaxation.
