Roth Conversion Strategies For 65 Retired Person


Like Marriage Converting A Traditional Ira To A Roth Is Not A Step That Should Be Taken Lightly

Roth Conversions In Retirement

Converting a traditional IRA to a Roth can shield your retirement savings from future tax increases, but there are pitfalls and trapdoors, too. Youll owe taxes on a conversion, and the up-front tax bill could be higher than you expectedparticularly if the conversion pushes you into a higher tax bracket. If your income tax rate drops significantly after you retire, the tax advantages could be modest or nonexistent. And as with any financial transaction that intersects with the tax code, youor your financial advisermust comply with multiple rules and regulations to avoid running afoul of the IRS.

Because many people, including retirees, believe taxes will rise in the future, Roth conversions are trendy, says Evan Beach, a certified financial planner with Campbell Wealth Management, in Alexandria, Va. But you see people get overenthusiastic about it, and they dont know what theyre doing.

The Tax Cuts and Jobs Act eliminated this option, so make sure youre prepared to pay the tax bill before you take the leap. Fortunately, nothing in the law says you must convert your entire IRA at once, and for many people, a series of partial conversions over several years is one of the most effective ways to avoid regrets.

These Key Factors Can Help You Decide

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The earlier you start a Roth IRA, the better. But even when you’re close to retirement, opening this special retirement savings vehicle can still make sense under some circumstances.

A Roth IRA is an individual retirement account that allows certain distributions or withdrawals to be made on a tax-free basis, assuming specific conditions have been met. Unlike their traditional IRA counterparts, Roth IRAs are funded with after-tax dollarsthey do not provide a tax deduction in the years you contribute money to them.

There is no age limit to open a Roth IRA, but there are income and contribution limits that investors should be aware of before funding one. Let’s look at the pros and cons.

Are Backdoor Roth Iras Allowed In 2021

In September, House Democrats proposed several changes to tighten the rules around backdoor Roth IRAs. The legislation would prohibit individuals who earn over $400,000 per year from converting pre-tax retirement savings accounts to a Roth IRA. Most of the changes would begin in 2022.

If the new law is approved, both the traditional IRA contribution step and the Roth conversion must be completed by the end of 2021 in order to do a backdoor Roth IRA for tax-year 2021.

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Leaving Money To Others

If you’re planning to leave retirement savings to heirs, consider how it may affect their taxes. Because of their RMDs, inherited traditional IRAs generate taxable income for heirs, often during their peak earning years. These distributions could incur taxes when they’d rather avoid them, or unintentionally push them into a higher tax bracket. Inheriting Roth IRA assets, which generally don’t incur any income taxes, can be a benefit to your heirs. In addition, the income taxes paid on a Roth IRA conversion may also help reduce the size of a taxable estate.

But there are many details to consider. For example, if your heirs are likely to be in a much lower tax bracket than you are, it may be advantageous to leave them a traditional IRA. That’s because it may be better for them to pay lower taxes in the future than for you to pay higher taxes now.

Also, Roth IRA conversions may be disadvantageous to those who intend to leave at least some of their assets to charitable institutions. Traditional IRAs can typically be left to charity without any tax bill at all for either party. So, in that case, conversion will mean that the tax was paid needlessly.6

If leaving money to others is part of your plan, no matter what your goals are, be sure to consult an estate planning attorney and think carefully before taking any action.

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Since the Setting Up Every Community for Retirement Enhancement Actmandated that inherited IRAs for most non-spousal beneficiaries must be fully depleted within 10 years of inheriting the account, Roth IRAs have become a viable estate planning tool.

While inherited Roth IRAs are subject to this 10-year rule, if the original account holder had satisfied the five-year rule prior to their death, then the beneficiaries will not be required to pay taxes on distributions from the inherited Roth IRA.

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Suggested Next Steps For You

The content contained in this blog post is intended for general informational purposes only and is not meant to constitute legal, tax, accounting or investment advice. You should consult a qualified legal or tax professional regarding your specific situation. Keep in mind that investing involves risk. The value of your investment will fluctuate over time and you may gain or lose money.

Any reference to the advisory services refers to Personal Capital Advisors Corporation, a subsidiary of Personal Capital. Personal Capital Advisors Corporation is an investment adviser registered with the Securities and Exchange Commission . Registration does not imply a certain level of skill or training nor does it imply endorsement by the SEC.

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Making Roth Ira Contributions

As we mentioned earlier, no matter how old you are, you can continue to contribute to your Roth IRA as long as youre earning incomewhether you receive a salary as a staff employee or 1099 income for contract work.

This provision makes Roth IRAs ideal for semi-retirees who keep working a few days a week at the old firm, or retirees who keep their hand in doing occasional consulting or freelance jobs.

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The Conversion Will Trigger Extra Taxes Or Costs:

When you do a Roth conversion, all of the money you convert from your traditional IRA or 401k will be taxed as income. However, it is not only the taxes that are costly, the extra income could impact other expenses:

  • College Costs: if you are paying for college, the income could impact financial aid packages.
  • Medicare: If you are 65 or older, the more money you earn , the more you might need to pay for Medicare.

To Roth Or Not To Roth: Evaluating Roth Versus Traditional Retirement Accounts

Executing a Roth Conversion in Retirement | Financial Symmetry

The Taxpayer Relief Act of 1997 introduced, for the first time, the opportunity for individuals to contribute to a tax-free Roth IRA for retirement. Up until that point, retirement accounts in the form of both IRAs and 401 plans provided a tax deduction when contributions were made to the account, in exchange for the fact that subsequent distributions at retirement would be taxable . Roth-style accounts were unique, though, in that contributions would no longer be tax-deductible but growth within the account would still be tax-deferred, and could ultimately be withdrawn tax-free .

From nearly the moment of their inception, the promise of a lifetime of tax-free growth made Roth accounts popular, especially amongst higher-income households that faced top tax brackets. However, to limit their use by high-income households, Roth accounts were established with income limitations, both on contributions themselves , and on Roth conversions . As a result, the highest-income households that faced the highest tax rates for which tax-free growth would ostensibly be most valuable were the ones that were least able to actually utilize Roth accounts!

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Disadvantages Of Converting To A Roth

The key disadvantage of a Roth conversion is taxes due on the converted value. There are a number of reasons your tax rate may be lower when you take distributions:

  • Many people have lower income in retirement.

  • When you take retirement distributions, they may represent a large portion of your income and straddle tax brackets, resulting in a lower average tax rate.

  • Some states dont tax retirement distributions or have no income taxes at all, which is important to consider if you might relocate.

There are also factors to consider specifically for the year of conversion. Higher taxable income that year could have one or more of these negative effects:

  • A higher tax bracket,

  • Less eligibility for student financial aid.

Will Your Tax Bracket Be Higher Now Or Later

No one really knows how tax rates could change over the next 5, 15, or 25 years.

If you believe your tax rate is lower now than it will be when you start taking withdrawals, a conversion may look promising because you’ll pay conversion taxes while you’re in a lower tax bracket and enjoy tax-free Roth IRA withdrawals later .

But if you believe your tax rate is higher now than it will be when you start taking withdrawals, a conversion could cost you more in taxes now than you’d save with tax-free withdrawals later.

So what do you do? It may help to “diversify” your taxesin other words, pay some of the taxes now and save some for later .

Give this some thought and talk with your tax advisor about what might be best for you.

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Can I Afford The Taxes

A Roth IRA conversion can be costly, because you must pay taxes on your existing IRA. Ideally, the money should not come out of your retirement savings. If you have to use funds from your traditional IRA in order to pay the taxes it will cost you to convert to a Roth, you’re better off letting the funds sit tight.

One technique to consider is to spread the cost of conversion over a few years. That may also prevent you from pushing yourself into a higher tax bracket.

Income Requirements For Roth Iras

Pay No Tax on Roth IRA Conversion

Although less restrictive than other accounts, Roth IRAs aren’t totally without limits. Regardless of your age, your income must be below a certain level for you to be eligible to contribute to a Roth. Also, contribution amounts to Roth IRAs can be limited or phased out. These limits depend on your tax filing status and how much income you earn.

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Tax Diversification Versus Roth Optimization To Navigate Future Changes In Tax Law

While many households can maximize Roth optimization strategies by simply focusing on the select number of years where their tax brackets are clearly higher or lower than usual , in some cases the driving concern is not that an individuals tax rates will be higher in the future , but that tax rates in the aggregate may be higher in the future. After all, if Congress enacts broad changes to the tax law that increases future tax brackets across the board, then tax rates may be higher for everyone down the road. Which would make Roth accounts the preferred approach for everyone.

Yet, in the end, while tax rates have changed significantly over the years as tax policy has changed, the actual average tax rate that households pay has been relatively stable for decades. In fact, while the top marginal tax bracket has varied as high as 90% to a low of 28% since World War II, the average tax rate of the top 1% has remained in a far tighter range from 30% to 45% over that time period. And the average tax rate of households overall has hovered even more narrowly between 23% and 33% .

Whereas a household that typically is in the 22% tax bracket is experiencing an off-year in either the 12% or 32% tax bracket has a known 10%+ swing that can be capitalized upon immediately .

When Would You Want To Convert To A Roth Ira

Converting an existing traditional IRA or another retirement account to a Roth IRA can make sense in many different situations, but not all the time. At the end of the day, the value of this investing strategy depends on your unique situation, your income, your tax bracket, and the financial goal youre trying to accomplish in the first place.

The most important detail to understand is that, when you convert another retirement account to a Roth IRA, you will have to pay income taxes on the converted amounts. It can make sense to pay these taxes now to avoid more taxes later on, but that depends a lot on your tax situation now and what your tax situation may be like later in life.

The main scenarios where converting to a Roth IRA can make sense include:

These are just some of the instances where it can make sense to convert another retirement account into a Roth IRA, but there may be others. Also note that, before you do anything drastic or begin a conversion, it can be smart to speak with a tax advisor or financial planner with tax expertise.

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What Is A Roth Conversion

A Roth conversion is when you take money that you have in a traditional 401k or IRA account and move it into a Roth 401k or IRA.

When you do this, you will need to pay taxes on the money you withdraw. However, any future gains will grow tax free.

The NewRetirement Retirement Planner enables you to model a Roth conversion against your own situation to better assess how the move could impact your finances.

Tax Implications To Consider When Converting

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The key tax implications include two main conversion opportunities:

  • An atypical, lower tax year may be a good time to convert.
  • The charitable contributions cap is based on adjusted gross income, which conversions increase.
  • And they include two main conversion limitations:

  • It could bump an investor into a higher marginal income tax rate.
  • Additional income from conversion is not subject to the 3.8% Medicare surtax, but it could trigger the tax on other passive income.
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    To Roth Or Not To Roth Part : Conversion Strategies For Millennials Gen Xers And Boomers

    Simply put, converting an IRA into a Roth IRA is making a proactive decision to pay taxes now … instead of paying them later.


    In our last article, we discussed how different generations might view contributions to traditional IRAs and 401s versus Roth IRAs and 401s.

    Now, were looking at how conversions work and who might benefit most by converting traditional retirement accounts into Roth retirement accounts.

    What is a Roth Conversion?

    Simply put, converting an IRA into a Roth IRA is making a proactive decision to pay taxes now instead of paying them later. If that sounds counter-intuitive to you, you arent alone. For generations, American taxpayers have been looking for ways to delay taxation on their growing assets, but what if you can benefit by paying taxes sooner?

    In some cases, due to changes in personal income, tax legislation, or strategic timing of income or deductions, taxes paid today might be smaller than those due many years from now.

    And unlike Roth contributions which require you to have earned income up to a certain threshold, there are no income limitations or earnings requirements impacting your ability to convert traditional retirement accounts into Roth accounts.

    Lets look at this by generation

    Millennials: Do it.

    How Roth Iras Can Help Save For Retirement

    Many people hit their peak earning years late in their careers. You might find you have extra money available to invest after the mortgage is paid off and the kids have finished college. Youll want to make the most of that money.

    Or, you might simply realize your retirement savings calculations are coming up short. Don’t feel bad: Whether it’s the cost of living, poor investment performance, or just stuff happening, many people find they have saved far less than they need. In any case, you may want to do whatever you can to make up for it while youre still earning income.

    Perhaps you’ve changed jobs, and the new employer doesnt offer a retirement plan like a 401. It’s up to you to make money-management arrangements. Of course, if you have high-interest debt or dont have an emergency fund, you should contribute any extra income to those priorities first.

    But if youre squared away on both accounts, contributing to a Roth IRA in your late 50s, 60s, and beyondassuming you qualifycan make a lot of sense. One of the benefits of a Roth IRA is that you’re never too old to fund it: There’s no age limit on making contributions to a Roth IRA.

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    The Tax Equivalency Principle Of Roth Versus Traditional Retirement Accounts

    Imagine for a moment that you learn you are going to receive a $5,000 bonus from your employer funds that you wouldnt need to cover your current household spending and are suddenly faced with the decision of where to save this additional income.

    On the one hand, you could contribute the full $5,000 to a traditional IRA and receive the associated upfront $5,000 tax deduction. On the other hand, you could contribute to a Roth IRA, but doing so will mean that you would have to hold aside some of the money for taxes , such that if your Federal-plus-state marginal tax rate is 25%, only $3,750 will actually end out in the Roth account .

    Assume that you leave the dollars in the retirement account long enough for its value to double . At the end of the time period, the Roth account will grow from $3,750 to $7,500, while the Traditional account will grow from $5,000 to $10,000. However, the Traditional account is still a pre-tax account, and being able to spend the money will require withdrawing it and paying the associated taxes which, if tax rates havent changed, will reduce its value by 25%, to a net value of $10,000 = $7,500 of after-tax value.

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