What to Know about Roth IRA Conversion’s (2024)

FAQs

What to Know about Roth IRA Conversion’s? ›

A Roth IRA conversion involves transferring retirement funds from a traditional-type IRA or 401(k) into a Roth account. The account holder must pay tax on the money they convert, but their withdrawals from the Roth account can be tax-free in the future.

Since a Roth conversion increases taxable income in the conversion year, drawbacks can include a higher tax bracket, more taxes on Social Security benefits, higher Medicare premiums, and lower college financial aid.

While there's no way to avoid conversion taxes completely, you can restructure them to make this much more manageable. By staggering out your conversion or timing it for years in which you have low tax liability or portfolio losses, you can reduce the impact of a Roth IRA conversion.

The Roth IRA five-year rule says you cannot withdraw earnings tax-free until it's been at least five years since you first contributed to a Roth IRA account. This five-year rule applies to everyone who contributes to a Roth IRA, whether they're 59 ½ or 105 years old.

If you expect yourself to be in a higher income tax bracket in retirement, a Roth IRA conversion may make sense. It's an opportunity to be tax-efficient with your retirement funds by paying the tax when your tax bracket is lower. In many instances, it is difficult to influence your tax bracket.

Taxes aren't due until the tax deadline of the following year, so you may have more than 15 months to pay the taxes on your converted balances. (Note: If you pay estimated taxes, you may need to make some payments sooner.)

In its simplest form, the decision in favor or against a Roth Conversion can be boiled down to one question: Are you paying a lower tax rate now than you will be in retirement? If yes, there's a good chance that conversions make sense. If not, a conversion likely does not make sense.

Despite the fact you can't convert an RMD, it doesn't mean you can't do Roth conversions after age 72. However, you need to make sure you get your RMD out before you do a conversion. Your first distributions from an IRA after 72 will be treated as RMD money first.

How much tax will I pay on a Roth conversion? ›

The sweet spot for a Roth conversion for many clients is between the time they retire and when they start taking Social Security. That's a window in which they have little income and the time is ripe for a Roth conversion.

Roth IRA - Conversion From an IRA Distribution Must be by End of Tax Year. The original conversion from a Traditional IRA to a Roth IRA must be completed within 60 days after the end of the tax year.

In some cases, a Roth IRA can provide you with so much reportable income that you're bumped into a higher tax bracket. With a bracket-bumping conversion strategy, you can avoid this scenario by converting only a portion of your funds to preserve your current tax bracket.

Converting a traditional IRA into a Roth IRA can provide tax-free income and estate planning advantages in the future. But you'll have to pay taxes on the money now, at what could be a higher rate than you'll owe in retirement.

Transforming your retirement savings. Funding a Roth IRA is appealing chiefly because doing so can give you tax-free income in retirement. The trade-off, however, is that you fund a Roth with after-tax money, meaning you don't get a tax deduction today. Plus, if your income is too high, you can't fund a Roth.

While it may not be the right choice for everyone, Roth conversions can provide tax diversification and help many investors increase their future financial flexibility in retirement. For retirees, having a Roth IRA can increase their after-tax income, since qualified withdrawals from the account are income tax-free.