Don’t miss the benefits of a Roth conversion

You’ve worked hard to save for the retirement of your dreams. But if most or all of your retirement savings are in traditional retirement accounts, you could be missing out on the benefits of a Roth IRA. These include tax-free withdrawals in retirement (giving you greater certainty of income and flexibility to manage taxes), no required minimum distributions (RMDs), a tax-free asset for your heirs if you don’t end up using it and the ability to access contributions tax and penalty free before retirement.

The good news is you can still gain access to these benefits using a Roth conversion.

The benefits of a Roth conversion

The most common way to fund a Roth account is by making regular contributions. However, Roth IRA contributions are not available if your income exceeds certain limits. Roth accounts are also much newer than traditional retirement accounts, so if you’ve been saving for a long time, you may not have had an opportunity to regularly contribute to one over time.

A Roth conversion is another way to fund a Roth account that involves moving funds from your traditional retirement account to a Roth account. Unlike making regular contributions, a Roth conversion does not increase the total amount of assets you have in a tax-advantaged retirement account. Rather, a Roth conversion changes the mix of your existing retirement assets. There are no income limits for Roth conversions or limits on how much you can convert. Consequently, Roth conversions offer a way to access a Roth account for those who may be unable to take advantage of, or who want to allocate more to, a Roth in a given year than what’s allowed with another contribution approach.

With a Roth conversion, you pay taxes now on any funds you convert, but you gain access to future tax-free withdrawals and the other benefits mentioned earlier, which could outweigh the tax you might pay today.

When should you consider a Roth conversion?

A Roth conversion could make sense if you:

• Don’t need the converted funds for five years AND
• Can pay related taxes from sources other than your conversion AND
• Meet one or more of the following:
  • You have significant assets in traditional retirement accounts.
  • You expect your future tax bracket to be higher than it is today.
  • You expect your taxable income to be high in retirement (in one of the top four federal tax brackets).
  • You want to pass tax-free assets to your heirs.

What else you should know

If the idea of a Roth conversion sounds appealing, keep in mind these important points:

1. Conversions are permanent. Once you convert funds to a Roth IRA, you can’t undo or reverse the transaction.
2. Medicare premiums may be affected, especially if you’re within two years of enrolling.
3. The deadline is Dec. 31, not the tax-filing deadline.
4. Pay the taxes from another source. This helps preserve more of your retirement savings.
5. Withdrawals within five years of conversion may incur a 10% penalty, even if you’re over age 59½.

How we can help

A Roth conversion can be a powerful tool to help you increase the amount of tax-free assets you have for retirement, but they do impact your current and future taxes, so it’s essential to talk to your tax advisor. Your financial advisor can work with your tax professional to review your situation, evaluate potential scenarios and help you determine whether a Roth conversion may be a good idea for you.