Benefits and Strategies to Converting an IRA to a Roth

Do you have a tax-deferred IRA that you are thinking to convert into a Roth IRA (Roth)?

A Roth conversion is the process of converting pre-tax assets into after-tax assets. Whether converting shares or cash that has yet to be invested, converting such assets to a Roth is a taxable event since a Roth account can only be funded with after-tax dollars. The benefit, however, is that the money in a Roth account grows tax-free, and you can withdraw funds after you retire without paying any taxes.

A taxpayer with a pre-tax IRA can convert any amount of assets in a year to their Roth. Such assets include traditional IRAs, SEP IRAs, and Simple IRAs. Converting current retirement accounts to a Roth can be a methodical, tax-efficient investment vehicle by helping to lower your lifetime taxes remarkably. While there is no way to avoid Roth conversion taxes completely, you can structure the conversion to make the tax burden more manageable. By reeling out your Roth conversion, or timing it for years in which you have low tax liability or portfolio losses, you can reduce the impact of a Roth conversion.

Another benefit is that a Roth is exempt from required minimum distributions (RMDs). These mandatory withdrawals from retirement accounts begin at age 73 and can create a tax burden on prosperous retirees. Roth owners are not subject to RMDs for as long as they live, making a Roth particularly apt for leaving inheritances. This may be especially favorable if you do not need to tap into your Roth funds during your lifetime.

When converting pre-tax money in a regular IRA to a Roth, you have to pay taxes on the amount at current marginal tax rates. The conversion amount is treated as ordinary income, which can raise your AGI enough to push you into a higher tax bracket. The result could be a high tax bill for the conversion year because the value of the Roth conversion is added to your taxable income. Therefore, an analysis should be performed to properly mitigate the tax impact of a Roth conversion.

If nearing retirement age and deciding on a conversion strategy, it is important to note that you cannot make penalty-free withdrawals from a Roth for five years after you open the account. Additionally, consider that the longer you take to convert your IRA, the more time your portfolio will have to grow. This could lead to more assets you may ultimately have to move and pay taxes on. You also could miss out on tax-free growth in the Roth during this time.

Strategies to Reduce Your Conversion Taxes

One way to mitigate the impact of the Roth conversion tax is if you have offsetting net operating losses in the same year. In this situation, the impact of the net operating loss can be netted against the addition to taxable income because of a Roth conversion. The benefit of offsetting loss against this type of income is subject to certain federal and state loss deduction thresholds.
Consider staggering to help with tax bracket management. It may make sense to avoid converting everything all at once, and instead convert a little bit at a time. By making the conversion in sections, you may be able to keep your tax bracket lower over a sequence of years. Keep an eye on how a conversion will affect your taxes, and convert enough to maximize your current bracket without pushing you into a higher one.

Converting a non-deductible IRA contribution to a Roth is a great planning strategy that will ensure that the account can grow without being required to take distributions during your lifetime or pay taxes on these assets in the future.

Speak to your financial advisor to explore ways to maximize your retirement income and minimize taxes.

Any accounting, business or tax advice contained in this communication, including attachments and enclosures, is not intended as a thorough, in-depth analysis of specific issues, nor a substitute for a formal opinion, nor is it sufficient to avoid tax-related penalties.