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Converting a Traditional IRA to a Roth Before or During Retirement

It doesn’t always make sense to convert a traditional IRA to a Roth IRA.  Your current and projected tax rate is often a main component of the decision, but there are other issues at play. Converting a traditional IRA to a Roth doesn’t make sense unless you have cash to pay taxes without dipping into your retirement savings.  It isn’t always advisable to convert a traditional IRA to a Roth IRA, but for some, the benefits are significant. Depending on your income, you may benefit more from converting to a Roth IRA either before or during retirement.

Why Convert a Traditional IRA to a Roth IRA?

The extent to which a Roth conversion will benefit an individual is unique to their situation. Often, a Roth will provide greater benefits to those who have significant assets in retirement. For example, those who rely on regular withdrawals for support do not gain from the ability to avoid required minimum distributions.

4 main benefits of converting to a Roth IRA:

  1. No required minimum distributions (RMDs)
  2. Tax-free withdrawals
  3. Leave a tax-efficient inheritance
  4. Give yourself greater flexibility for tax planning – and tax saving – opportunities in retirement

No mandatory withdrawals in retirement

Unlike IRAs, a Roth IRA doesn’t have required minimum distributions (RMDs) during the original account owner’s lifetime.

Tax-free withdrawals!

Five-year rule for Roth IRAs is as follows: 5 years after the year in which you make a Roth conversion you’re able to withdraw funds for qualifying events without a penalty. Further, for tax purposes, withdrawals come from after-tax contributions and conversion dollars first; earnings last. After-tax contributions aren’t subject to double-taxation.

If you wait until age 59 1/2 to take money out of a Roth IRA and have passed the 5-year holding period, then your investment earnings and growth will also be tax-free!

Tax-efficient legacy gifts

A Roth IRA is an advantageous way to leave assets to beneficiaries, as the account will pass onto an heir income tax-free, assuming a five-year holding period has been met by the decedent. Note: Roth IRAs may still be subject to estate tax. Under the Secure Act, beneficiaries who inherit a retirement account from a non-spouse can no longer ‘stretch’ the distributions over their lifetime. Instead, they have to take the funds in 10 years.

Tax planning for tax savings during retirement

For investors facing higher income tax brackets in retirement due to the impact of RMDs on tax-deferred assets, a Roth can provide needed tax diversification and flexibility.

Converting a traditional IRA to a Roth

Before converting a traditional IRA to a Roth, consider if the benefits will make up for the loss of tax-deferred growth.

Should you convert a traditional IRA to a Roth?

It depends! A Roth conversion doesn’t always make sense so consider the specifics of your situation and goals.

A key factor when converting a traditional IRA to a Roth IRA is your current and projected tax bracket. Converting a traditional IRA into a Roth IRA means paying income tax on previous tax-deductible contributions and investment growth.

The tax due is dependent on your tax bracket at the time of withdrawal or conversion. Therefore, this strategy is best for individuals in a lower tax bracket relative to the future. Keep in mind: the amount you convert will be added to your taxable income for the year. This has the potential to push you into a higher tax bracket.

Will your taxes be lower in retirement?

There is a common misconception that retirees will always be in a lower tax bracket in retirement. Retirees with a significant portion of assets in tax-deferred accounts find themselves in a much higher tax bracket once required minimum distributions begin.

Uncertainty about future tax rates or changes to the tax code are good reasons to convert to a Roth. But if you don’t have the funds in a brokerage account to pay the taxes upon conversion, this is likely not a beneficial strategy.

The good news is that the full conversion does not have to happen at once. One traditional IRA to Roth conversion is allowed each year, regardless of income.

Avoid the Double-Tax Trap on Non-Deductible IRA Contributions

Converting an IRA to a Roth IRA before or after retirement

There are no age limits for Roth conversions. If you’re working, depending on your income, you may want to wait until retirement to convert to a Roth.

Planning to move to a tax-free state like Florida or out of a high-tax state like California during retirement? If so, you may be better off waiting until retirement to convert to a Roth. If you wait until retirement, be conscious of RMD age, which is currently 72. You’ll have to take your RMD before converting if you’re subject to mandatory distributions. Together with your other retirement accounts, a big Roth conversion later in retirement could have negative tax implications.

Before retirement, if you unexpectedly lost your job or are going to be in a low tax bracket for other reasons, it may make sense to convert in the current year. But you’ll want to ensure you have cash to pay taxes without going into your IRA.

A market downturn poses unique opportunity to convert to a Roth IRA

If your traditional IRA suffers big losses, there’s an opportunity to convert to a Roth IRA while the value is lower. Once the market recovers, you’ll benefit from converting to a Roth during the downturn.

You may need to act quickly, though. Big swings in the market usually fall near each other. By the time you make up your mind, the opportunity could have passed.

Between January 2000 and December 2019, if you missed the S&P 500’s best 10 days your average annualized total return would be 2.44% compared to 6.06% had you stayed fully invested. Missed the best 20 days? You’re essentially flat. Again, these swings happen really fast. During this period 60% of the best 10 days fell within two weeks of the worst 10 days.

Differences between a traditional IRA and a Roth IRA

Why bother converting to a Roth? Here are some of the key differences between the accounts.

A traditional IRA (individual retirement account) allows any person with earned income to make annual contributions within IRS limits. While the ability to make tax-deductible contributions will depend on your income and whether you’re covered by another retirement plan, those ineligible for favorable tax treatment can still contribute on an after-tax basis.

Contributions to a Roth IRA will always be made with after-tax dollars, but not everyone is able to participate. The phase-out range for single filers in 2022 is $129,000 – $144,000 and for married couples filing jointly $204,000 – $214,000.

Aside from the tax treatment of contributions and withdrawals, the next biggest difference between traditional and Roth IRAs is required minimum distributions (RMDs). The Secure Act, which was passed at the end of 2019, changed the age some retirees will need to begin distributions from non-Roth tax-deferred retirement accounts. Required minimum distributions must begin at age 70 1/2 or 72 (if born on or after July 1st, 1949).

Roth IRAs are not subject to RMDs, though Roth 401(k)s are. This gives retirees greater flexibility in retirement and a way to leave assets to heirs on a tax-free basis.

Before taking any action, always weigh the pros and cons as it relates to your personal financial situation.


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