Wouldn't it be nice to pay less income tax in retirement? One way is with a tax-advantaged strategy called a Roth IRA conversion. This action can help lower your taxable income later in retirement. A Roth IRA conversion involves repositioning a traditional IRA or qualified employer-sponsored retirement plan assets into a Roth IRA. There are a few reasons investors pursue this conversion strategy.
A Roth IRA:
Before initiating a Roth IRA conversation strategy, ask yourself these five questions prior to making your decision:
#1- Can you pay the taxes? Since traditional IRAs and other qualified retirement plans are tax-deferred, upon converting assets into a Roth IRA, the account owner must pay income tax on the amount they convert. Also, taxes are due upfront when the conversion occurs.
#2- Are you comfortable increasing your Adjusted Gross Income (AGI)? A Roth IRA conversion will raise your income in the year that the conversion occurs, increasing your AGI, which can impact your taxes by moving you into a higher income tax bracket. In addition, if you are retired, be mindful that Medicare Part B uses your two previous years' income to calculate your monthly premium. Therefore, the conversion may increase your Part B payment for at least two years.
#3- Will you lose eligibility for specific tax write-offs? For example, the child tax credit and student loan interest deduction are determined by personal income. Initiating a Roth IRA conversion may mean you lose these deductions if your AGI increases.
#4- Will you need the money within five years? Roth IRAs typically offer penalty and tax-free withdrawals anytime on contributions. Still, investors must wait five years to access the funds without a 10% penalty when using conversion monies, regardless of age. So it’s something to think about whether you’ll need money from your Roth IRA before the five-year rule sunsets. If that’s a possibility, there may be a more appropriate strategy for you.
#5- Does your qualified retirement plan allow Roth IRA conversions? If your funds are inside your employer's retirement savings plan, check the plan's documents to see if a Roth IRA conversion is allowed. Then, consult your employee handbook, HR department, or the employer-sponsored retirement plan's custodian for answers about your situation.
We’re happy to make a recommendation for knowledgeable tax advice or meet with your tax professional to determine how a Roth IRA conversion may impact your taxes at the time of conversion. Contact our office today to visit about this strategy and other-tax advantaged strategies that may be appropriate for your situation. Together we can ensure your financial plan and tax circumstances are appropriately aligned.
Courtesy of Fresh Finance.
5 Questions to Help Determine if a Roth IRA Conversion is Appropriate for You.
February 07, 2023