Roth Conversions – Why Consider It?

A Roth Conversion is the process of moving funds from a pre-tax retirement account, like a Traditional IRA or a401K, to a Roth IRA. The money converted from a traditional account would be included in your taxable income - but once it is in the Roth account, it grows tax-free. There are many financial and personal considerations to a Roth conversion or backdoor contribution – let’s review the most common.

Eligibility

Are you earning income and fall below the IRS Income limits ($165,000 Single/$246,000 MFJ)? Congratulations – you are eligible to contribute to a Roth IRA! However, if you do not satisfy the requirements, a Roth Conversion could be beneficial.

Liquidity

There is a minimum 5 year holding period on any money withdrawn for a Roth Conversion. If you are reliant on your IRA or 401k withdrawals for personal living expenses, you should consult your financial planner and CPA to determine a conversion timeline. This would include a schedule of conversions over the course of years, and an analysis of the potential tax burden you will face.

Jump in Tax Bracket

The money converted to a Roth is recognized as taxable income – since you were able to put the money into the account pre-tax, you must recognize it as income in order to take advantage of the tax-free growth of the Roth account. This may mean a considerable increase in your tax rate. As mentioned earlier, spreading the conversions can help you avoid paying unnecessary tax.

Estate Planning

Many people want to leave a legacy for the next generation while avoiding large tax burdens for their beneficiaries. A Roth conversion would mean that you pay the tax, and your beneficiaries can continue to let that account grow tax-free. With uncertainty surrounding estate tax limits due to TCJA sunsetting at the end of this year, many folks are converting their retirement accounts in anticipation of stricter regulations. Working with your financial planner and CPA in tandem can help ensure you aren’t converting your assets in a panic. They keep a pulse on changes to estate tax and can help you formulate a proactive conversion plan.

Once you and your team of professionals weigh the benefits and potential tax implications, they can help you take the next step of a Roth Conversion. It is important to keep both your financial planner and your CPA in the loop – this allows them to provide the best possible outcome.