Roth Conversions

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Hello and welcome to Cornerstone clips. Today, we’re going to be discussing Roth conversions. Before we get into Roth conversions, let’s recap the two main types of retirement accounts, Traditional IRA and Roth IRA. Traditional IRA’s are done on a pretax basis, so you get a tax deduction on the way in and you pay taxes when you take it out. When you withdraw it in the future.

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Roth IRAs are the other way around. When you pay, you put your money in after tax, and then your withdrawals are ultimately tax free.

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So let’s get into Roth conversions. So let’s imagine you have a pretty substantial sized Traditional IRA and you’re realizing, wow, I’m going to have a lot of taxes due when I take this money out in retirement. So you’re looking for ways to change the tax status.

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Roth conversion allows you to take money from that Traditional IRA, convert it to Roth, which is merely changing its tax status from being tax deferred, and ultimately paying paying taxes in the future to paying the taxes now and changing its tax status so that the growth is now tax free in the future. This is a strategy that helps you. Lock in your current tax rate so that you can get the benefit of the tax rate today.

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And then it creates the tax-free growth. So as you leave it in overtime and generate more and more growth, you have more money to come out tax free in the future. A couple considerations to think about when you’re doing a Roth conversion is do you have money outside of your retirement accounts to pay the taxes. So when you convert money from a Traditional IRA?

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To a Roth, it counts as income in that year, and you have to pay taxes on that on that income. At your current tax rate. So if you don’t have money outside of your retirement account.

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You can’t really do the Roth conversion because you have to have available money to pay the taxes. Another consideration is what tax bracket are you in? Do you expect to be in a higher tax bracket in the future or a lower tax bracket? If you expect to be in a higher tax bracket, it can make sense as you pay taxes at a lower rate. Now, depending on how much you convert that can push you into a higher tax bracket today, so paying attention to where those brackets are and how much you’re trying to convert along the way can be careful considerations that need to be looked at?

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This is a really smart strategy that allows you to change tax status and create different opportunities, but there are several things that go into it. So if you think it might be something for you or just want to talk about it a little more. Give us a call here at the office. We’ll be happy to sit down and look at your unique situation.