Moving assets from a good old fashioned IRA into a Roth IRA is called a “Roth Conversion.” The main difference between the two types of IRAs is that one is taxed when funds are distributed (the traditional IRA) and the other is taxed prior to making the contribution (Roth IRA). Your contribution may be tax deductible up front on a traditional IRA contribution or you can get the benefit of tax free distributions on a Roth IRA. Both can be terrific savings vehicles.
So why would anyone consider “converting” their IRA? Why pay tax unless I have to? Well, here are five reasons why some investors decide to do it.
- Thinking of the Kids – A Roth IRA inherited by your children will continue to grow tax free over their lifetimes. Although the inherited Roth will be subject to RMDs during your kid’s lifetime, the ability to stretch the opportunity for tax free growth over a second generation can be valuable. Your kids will thank you!
- Low Income Year – If you’re in a period of lower taxable income this may be a good time to consider a Roth conversion as you’ll pay less tax to accomplish the goal.
- My Nest Egg is Mostly IRA/401k Money – When you turn 70.5 years old, the IRS wants to take a tax bite from your IRA. They call it a Required Minimum Distribution (RMD) and on large IRA or retirement plan balances it could be a sizeable amount. If you turn 70.5 this year and have $1,500,000 in IRA/retirement plans your RMD will be $54,745 in taxable income. Prior to turning 70.5 it can be advantageous to start a plan to whittle down your traditional IRA account balances by converting to a Roth IRA.
- The Golden Window – Typically between retirement and the age of 70.5 clients “earn” less money. This can be a very attractive period for a Roth conversion since Required Minimum Distributions (RMDs) start at the age of 70.5 and are fully taxable as income. If clients have a large percentage of their retirement assets in traditional IRAs this can be a good period to convert a portion to a Roth IRA. Your taxable income may be increasing substantially when RMDs kick in so you can accomplish the goal at a lower tax cost now!
- Tax Free… That’s For Me – If you’re concerned that tax rates will be trending upward or want a vehicle for your money to grow tax deferred and have distributions be tax free, a Roth IRA may be right for you!
A Roth conversion can be a smart strategy under various circumstances, but the decision isn’t always straight forward. There are pros and cons to be understood, and investors should consider the implications in light of their personal financial situation. At Beacon Pointe, we pride ourselves on being a valued thought partner in navigating these discussions. As always, Beacon Pointe is available to help you address any portfolio related tax concerns. We will work directly with your tax advisor regarding your specific situation. Do not hesitate to call us with any questions or to discuss steps you would like taken in your portfolio.
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