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The Beauty of a Roth Conversion

By on December 3, 2014
Categories: RETIREMENT

This is a good time of year to consider whether converting a traditional Individual Retirement Account into a Roth IRA makes sense.

High-income investors used to be prohibited from completing a Roth conversion, but the rules changed back in 2010 that allowed investors of any income to take advantage of this financial move. The federal change unleashed a flood of conversions by wealthy individuals.

The reason why you may want to convert some of your retirement assets into a Roth is to shrink your future tax bite. What follows is a closer look at what makes Roth conversions attractive.

Roth IRA Benefits

Just like a regular IRA or a workplace retirement plan, the money inside a Roth is protected from taxes as it grows within the account. There is, however, a huge difference in how these accounts behave when investors enter retirement.

Retirees who pull money out of a traditional IRA will owe income taxes on all their withdrawals. And if the withdrawals are big enough, it could boost the retiree into a higher tax bracket, which will trigger an even worse tax bite.

In contrast, retirees do not have to pay taxes when they withdraw money from their Roth IRAs. Another attractive feature for affluent investors is that Roth investors aren’t forced to make mandatory withdrawals from their Roth accounts. In contrast, investors must start pulling money out of their traditional IRAs when they reach the age of 70 ½.

Here’s another bonus of a Roth IRA: loved ones lucky enough to inherit one of these IRA’s typically do not have to pay taxes on their withdrawals either.

Conversion Nuts & Bolts

Sounds great so far, right? There is some pain involved, however, when making the switch. When converting a regular IRA into a Roth, an account owner must pay income taxes on the amount being moved. So if the investor wanted to move $100,000 into a Roth and he/she is in the 39.6% tax bracket, the conversion tab would be $39,600.

If you decide that you want to do a Roth conversion, you can transfer the entire balance or a partial amount from the traditional IRA. You can do the same thing with money in a 401(k) or 403(b) once you leave your job.

Because the conversion tax is tied to your income tax bracket, converting traditional IRA assets can be more desirable during a year when your income is lower.

Whether a Roth conversion would be right for you will depend on a variety of factors. Before making a move, it makes sense to consult your investment advisor or tax professional.

Learn More…

Stretching an Individual Retirement Account

Using Your IRA To Make Charitable Gifts

Should You Trust a Retirement Adviser?

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