Plant Your Retirement Seeds in a Roth IRA: Why Now Is the Time for a Conversion
Do you want to keep more of your hard-earned money in retirement? Of course you do — and one smart strategy to consider is a Roth IRA conversion.
Think of it like planting an orchard. Your retirement funds in a traditional IRA or 401(k) are like planting an apple tree where you don’t pay for the sapling upfront, but you’ll owe a portion of every apple you harvest later. A Roth IRA is like buying a young apple tree outright. It costs more initially, but every apple you harvest is yours to keep, tax-free.
When you take money out of your traditional IRA in retirement, you have to pay taxes on it — like giving away some of your apples. But with a Roth IRA, qualified withdrawals are tax-free. You pay the taxes upfront when you do the conversion — like paying for the tree when you plant it — and then your money grows tax-free, and you can withdraw it tax-free in retirement.
- Consider This Example: Let’s say you move $10,000 from your traditional IRA to your Roth IRA. You’ll pay taxes on that $10,000 based on your current tax rate. But once that’s done, the $10,000 is in the Roth, growing tax-free, and you’ll never owe taxes on it again, even when you take it out in retirement.
- Keep in Mind: You don’t want to use the money you’re converting to pay the tax bill. Keep that $10,000 in the Roth IRA working for you, and pay the taxes from a different source.
Is a Roth Conversion Right for You?
| Consider a Roth Conversion If: | You Might Want to Reconsider If: |
|---|---|
| You anticipate being in a higher tax bracket in retirement. This could be due to factors like significant retirement savings, pension income, or higher anticipated earnings. | You expect to be in a lower tax bracket during retirement. This might be the case if you plan to downsize, have minimal retirement income needs, or anticipate reduced expenses. |
| You have a long time horizon until retirement, allowing for greater tax-free growth potential within the Roth IRA. | You are nearing retirement or anticipate needing to access your retirement funds soon. |
| You want to minimize taxes for your beneficiaries or have significant assets to pass on.You have limited assets or are primarily concerned with minimizing current tax liabilities. | You have limited assets or are primarily concerned with minimizing current tax liabilities. |
| You have sufficient funds outside of your retirement accounts to pay the taxes due on the conversion comfortably. | You have limited liquidity or would need to withdraw funds from your retirement accounts to cover the tax liability. |
| You’re looking for flexibility and control over your retirement income and tax planning. | You prefer a simple approach to retirement planning and are comfortable with traditional IRA distribution rules. |
Now is the Time for a Roth Conversion
The end of the year is a strategic time to consider a Roth conversion for a few reasons:
- Income Clarity: You have a clear picture of your income for the year. This helps you determine the optimal amount to convert to stay within your current tax bracket and avoid jumping into a higher one.
- Tax Planning: You can proactively plan for the tax liability associated with the conversion and make any necessary adjustments before the year ends.
- Potential Tax Changes: Converting before the end of the year allows you to take advantage of current tax rates, which could be higher in the future.
Long-Term Benefits of a Roth Conversion
Roth IRA conversions have several advantages, including:
- Reduced Future Taxes: Roth conversions can significantly reduce your taxable income in retirement, especially if you anticipate being in a higher tax bracket.
- Maximize Social Security: By reducing your taxable income in retirement, Roth conversions can help you keep more of your Social Security benefits, which are partially taxable above certain income thresholds.
- RMD Avoidance: Unlike traditional IRAs, Roth IRAs are not subject to Required Minimum Distributions (RMDs) during your lifetime, providing more flexibility and control over your retirement income.
- Estate Planning: Roth IRAs offer tax advantages for your beneficiaries, allowing you to pass on wealth tax-free.
The Bottom Line
We often ask our clients: “Do you want to pay tax on the seed or the harvest?” With a Roth conversion, you’re paying tax on the seed (your initial investment), so you can enjoy the harvest (your retirement income) tax-free.
If you think a Roth conversion might be right for you, contact us today for a free consultation. And download our latest resource to learn more.
