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Roth Conversions: What You Need to Know

About the author: Lamar Watson, CFP®, is a Fee-Only Financial Advisor in the Washington, D.C. area, that works with clients virtually across the country. Lamar's work with his clients focuses on budgeting, employee benefits, paying down debt, buying their first home, and investing. Lamar is the Founder of Dream Financial Planning, a virtual financial planning firm specifically designed to help young professionals and minorities take control of their finances and fulfill their dreams. Feel free to schedule a complimentary consultation to learn how we use the The DREAM Financial Planning Process ™ to help our clients achieve their goals. 

When opening a retirement savings account, you’re typically presented with the option of choosing between a Traditional or Roth IRA. While you may have stuck with a Traditional IRA for the initial tax savings, it’s possible you could change your mind and opt for tax-free retirement income instead. Making this switch is called a Roth conversion. Should you consider taking advantage of this opportunity, or are you better off sticking to your current savings strategy? We’re discussing what you need to know below. 

Traditional IRA

A traditional IRA allows you to save on a pre-tax basis towards your future retirement. A contribution to a Traditional IRA can reduce your taxable income and lower your tax bill. Your money grows tax-deferred and once you are ready to take distributions from the account (in retirement, hopefully), you will pay taxes. If you are under age 59 ½ and decide you need to take a distribution from your traditional IRA, a penalty can be assessed.

Traditional IRAs are subject to RMDs (Required minimum distributions). As part of the new SECURE Act, RMDs now begin at age 72; previously, they began at age 70 ½. Regardless if you need it or not, RMDs require you to withdraw the money from your account. If you have a substantial amount in your IRA, this rule can be unfortunate due to higher tax rates. Also, by having to distribute funds from the IRA, they no longer benefit from tax-deferred growth.

As for contributions, the limit for 2020 is $6,000 and if you’re over the age of 50, you can contribute an additional $1,000. Anyone can contribute to an IRA as long as they have earned income. If you aren’t eligible to make tax-deductible contributions, then you can make nondeductible contributions with after-tax money to an IRA. This is when the Roth conversion strategy comes into play.

Roth IRA

A Roth IRA is another type of tax-advantaged retirement account, but it is taxed differently from a traditional IRA. When you make a Roth contribution, the funds are deposited after tax. This means taxes are paid on the front end. You won’t owe income taxes when you withdraw money from your Roth IRA, as long as those withdrawals occur after age 59 1/2 and the account has been open for at least five years. You can always withdraw your own contributions tax and penalty-free.

There is no RMD requirement with a Roth IRA, which is a great benefit. As a reminder, when you turn 72, you must start taking money from a Traditional IRA. Meanwhile, your money in a Roth IRA will continue to grow tax-free with no RMD. 

Roth IRAs are also great legacy planning vehicles, but income limits may not allow contributions. The following table illustrates the restrictions for Roth IRAs in 2020:

If you are above the income limits for contributing directly to a Roth IRA, it’s still possible to get money into your Roth IRA. Planning techniques such as a Roth conversion will allow you to contribute regardless of income

What Is a Roth Conversion?

A Roth conversion refers to the act of converting a Traditional IRA account into a Roth IRA account. A Traditional IRA account is created using pre-tax dollars, meaning the distributions you take from a Traditional IRA account in retirement is taxable income. A Roth IRA is created using after-tax dollars, meaning the distributions you take from a Roth IRA account in retirement is tax-free (because tax has already been paid).  

Additionally, a Roth IRA can be an appealing option for some because it does not include a required minimum distribution age. This means that you can continue to save and grow tax-free dollars for the remainder of your life. 

Considerations to Make Before Doing a Roth Conversion

While a Roth conversion could be a great option for some, it could be a costly mistake for others. That’s why we’ve outlined four important considerations to make before converting your Traditional IRA into a Roth account. I'll also mention that doing a Roth conversion isn't as easy as it seems.  To make sure you execute this strategy successfully, please contact your Financial Advisor. If you don't have an advisor feel free to contact us check out our guide Should I Consider Doing A Roth Conversion

Consideration #1: Your Timeline to Retirement

If you’re retiring within the next few years, you may want to forego a Roth conversion. Why? Because the money you convert into a Roth IRA must stay there for a five-year holding period. If withdraws are made before the five years is up, you could be hit with a 10 percent penalty and/or additional income taxes. 

Consideration #2: Tax Obligations

When considering a Roth conversion, you simply can’t ignore the tax implications associated with this move. While your aim may be tax-free income in retirement, you will have to pay taxes on that income at some point. You need to be prepared to pay the taxes on this additional income, which could very well push you up into a higher tax bracket. While it’s possible to cover the difference using a portion of the distribution itself, this is typically not advised for two reasons: you’d be robbing your future retirement of income and you may be subject to a 10 percent penalty for withdrawing the funds. 

Consideration #3: Your Future Tax Bracket

One of the main reasons an individual chooses to do a Roth conversion is for the advantage of tax-free withdrawals in retirement. With that in mind, you’ll want to take into consideration whether your tax bracket will be higher or lower in the future when you anticipate withdrawing the funds. If you believe you’ll be in a lower tax bracket come retirement, it may be worth waiting to withdraw the funds then. On the other hand, if you’ve experienced a year of interrupted or lowered income (lost a job, missed out on a bonus, etc.), you may be in a lower tax bracket now than you would when entering retirement.

Consideration #4: How Much to Convert and When

If you’re on the cusp of a higher tax bracket, but still want to do a Roth conversion, you do have the option to convert a portion at a time. By spreading the conversion across several years (as opposed to one lump sum), you can lower your yearly tax obligation. 

How to Make a Roth Conversion

The IRS offers three possible ways for an individual to convert funds from a Traditional IRA into a Roth IRA account. These methods include: 

  • Rollover: You are given the funds and must put the funds into a Roth IRA account within 60 days. 
  • Trustee-to-trustee transfer: The institution currently housing your Traditional IRA transfers the distribution to a different institution where it'll be held in a Roth IRA. 
  • Same trustee transfer: The institution currently housing your Traditional IRA is able to also house your Roth IRA, and they roll the account over for you.1

Being able to withdraw income tax-free in retirement is an appealing option for many. And it’s good to know that while you may have chosen to open a Traditional IRA years ago that you have the option to convert it at any time. Before making any moves to your retirement savings account, make sure to speak with your Financial Advisor first. Together, you can go over these important considerations in regards to your unique financial situation. 

Mega Backdoor Roth: The Supercharged Roth

My good friend Travis Gatzemeier at Kinetix Financial Planning discussed the Mega Backdoor Roth earlier this year.  I included a brief excerpt from his discussion below, but I encourage you to read his entire blog post about the Mega Backdoor Roth.

In general, individuals in a position to consider the mega backdoor strategy are typically in a high tax bracket, based purely on the fact that they are not only able to max out the standard annual savings limits but also have additional saving capability. And those in a high tax bracket will usually benefit from first taking advantage of saving strategies that can lower taxable income. 

Of course, one of the first places to look is maxing out contributions to a traditional 401(k). Next, it may also be a smart idea to consider funding an HSA, which will further reduce taxable income while increasing tax-deferred and tax-free savings. Finally, if you have children and are interested in saving for their college education, it may make sense to think about contributing to a 529 account. Saving for retirement should be a priority for everyone, but it is always a good idea to look at all of your savings goals as well. Read the remainder of his post here.

Dream Financial Planning Process ™

Whether you're managing student loan debt, starting a business, or considering buying your first home, the DREAM Financial Planning Process™ is tailored to the unique needs of busy professionals is their 30s and 40s. This process focuses more on short-term goals while you grow and evolve in your personal and professional life. If you're looking for guidance on: Financial Planning, optimizing employee benefits, budgeting, student loans, and managing your 401k or investments we can help.

Complimentary Consultation

With uncertainty surrounding the economic stability of our country, it's okay to have fears and anxieties surrounding your own savings and investments. The most productive course of action from here is to reach out to Dream Financial Planning (or whoever your trusted advisor might be) and discuss your options. It's easy to have knee-jerk reactions when it feels like the bottom is falling out, but it is imperative to make decisions using research-backed data and a level head. If you'd like a Complimentary Review and risk assessment of your investment portfolio feel free to send me an e-mail.

Monthly Newsletter

On the first Thursday of every month I send out a monthly newsletter with tips and tricks to help you manage your Finances. In the June Newsletter I discuss what you should know if you're considering a Roth Conversion. I also mention the surging stock market and better than expected unemployment numbers. There's also a friendly reminder about the difficulties of trying to time the market.



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  1. https://www.irs.gov/retirement-plans/retirement-plans-faqs-regarding-iras-rollovers-and-roth-conversions

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