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Year End Planning Roth Conversions

Year End Planning: Roth Conversions

What exactly is a Roth conversion?
A Roth conversion occurs when you take savings from a Traditional IRA or employer-sponsored retirement plan — such as a 401(k), 403(b), or governmental 457(b) — and convert them to a Roth IRA. When converting your pre-tax savings, you’re including the converted amount as income on your taxes now to get the tax-free growth benefits of a Roth IRA later.

What are some key benefits of a Roth conversion?
Roth IRAs offer a number of potential advantages over Traditional IRAs. While Traditional IRAs allow for tax-deferred growth of retirement assets, with taxes being due when distributions are taken, qualified Roth IRA withdrawals are tax-free, as long as you hold the Roth for at least five years and are at least age 59 1/2. Withdrawals may be subject to a 10% IRS tax penalty if distributions are taken prior to age 59 1/2.

Another benefit of a Roth IRA is that unlike Traditional IRAs, you are not required to begin taking distributions at age 70 1/2.

A Roth IRA can be used as an estate planning tool because the assets can be passed on tax-free to your heirs.  The people who inherit your Roth IRA will have to take annual RMDs, but they won’t have to pay any federal income tax on their withdrawals as long as the account’s been open for at least 5 years.

Everyone knows that it is important to diversify your investments… well it is just as important to diversify your retirement account types. Tax diversification of retirement assets allows for more flexibility to manage taxable income in retirement. 

What are a few things to consider before converting?
Your availability of funds to pay income taxes. The benefits of a conversion are increased if the income taxes due can be paid out of non-retirement assets. To help manage your tax liability, you may choose to convert just a portion of your assets. There is no limit to the number of conversions you can do, so you may convert smaller amounts over several years.

You should also consider your time horizon. Generally, if you will need the funds within the next five years, a Roth IRA is not a good choice. This is because a five-year waiting period is required if you are under age 59 1/2 before you can distribute the converted amount penalty free. The longer the assets in the Roth IRA can be left untouched, the greater the benefit of tax-free earnings accumulation.

Generally, a Roth IRA conversion makes sense if you:

  • Won’t need the converted Roth funds for at least five years.
  • Expect to be in the same or a higher tax bracket during retirement.
  • Can pay the conversion taxes without using the retirement funds themselves.
  • May not need the funds for retirement and may want to transfer them to your heirs.

Check out next week’s post to find out strategies that you can pair with a Roth conversion to potentially offset your tax liability.

Not sure how to get started?  Contact us to help you get determine if a Roth conversion could work best for you.



Article provided by Broadridge Investor Communication Solutions, Inc.  Any opinions are those of the advisors of Sweet Financial Services and not necessarily those of Raymond James. Investments mentioned may not be suitable for all investors. The information has been obtained from sources considered to be reliable, but we do not guarantee that the foregoing material is accurate or complete. Any information is not a complete summary or statement of all available data necessary for making an investment decision and does not constitute a recommendation. Like Traditional IRAs, contribution limits apply to Roth IRAs. In addition, with a Roth IRA, your allowable contribution may be reduced or eliminated if your annual income exceeds certain limits. Contributions to a Roth IRA are never tax deductible, but if certain conditions are met, distributions will be completely income tax free. Unless certain criteria are met, Roth IRA owners must be 59½ or older and have held the IRA for five years before tax-free withdrawals are permitted. Additionally, each converted amount may be subject to its own five-year holding period. Converting a traditional IRA into a Roth IRA has tax implications. Investors should consult a tax advisor before deciding to do a conversion. RMD’s are generally subject to federal income tax and may be subject to state taxes. Consult your tax advisor to assess your situation.

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