Ask Yourself These 3 Questions Before Doing a Roth Conversion

October 10, 2016

 

If you’re like many workers or recent retirees, much of your retirement assets are probably in either a 401(k) or a traditional IRA. Over the past several decades, the 401(k) has become one of the most popular vehicles for saving for retirement. The traditional IRA is also popular as a supplemental savings vehicle and also as a destination for 401(k) rollover money when people switch jobs.

 

While 401(k) plans and traditional IRAs may be effective tools for saving money, they present challenges in retirement, especially when it comes to distributions. In both plans, you may get some tax benefit when you contribute money, and you receive tax-deferred growth as long as money stays in the account.

 

However, all distributions from the plans are taxable, which could be a problem in retirement. Most retirees are looking to cut their expenses, including taxes. Qualified plan distributions could create new taxes and could increase taxable income, which affects things like taxes on Social Security benefits and premiums for Medicare.

 

 

Additionally, both 401(k) plans and traditional IRAs have required minimum distributions (RMDs), which are mandated withdrawals that begin at age 70½. If you don’t need the withdrawals and simply wish to keep growing your assets as a benefit for your heirs, those RMDs may be frustrating.

 

Fortunately, there’s an alternative. You can convert those 401(k) or traditional IRA funds into a Roth IRA. With a Roth, you pay no taxes on distributions after age 59½. There is also no requirement to take distributions at age 70½. You can let the assets grow as long as you would like.

 

Roth conversions aren’t for everyone, though. There are a few important points to consider before you start the process. Below are three questions to ask yourself before you start a conversion:

 

Do you need income within five years?

 

Roth distributions are generally tax-free, assuming the distributions meet qualification standards. The first qualification is that you must be either age 59½ or older, disabled or dead. The second is that the Roth account must be open for at least five years.

 

Effectively, that means you need to do the conversion and then wait five years to take withdrawals if you want to take advantage of the tax-free distributions. If you need income sooner than that and have no other sources, a Roth conversion may not be the right strategy.

 

Do you have other funds to pay the taxes?

 

Remember, 401(k) and traditional IRA accounts have taxable distributions. That treatment doesn’t go away just because you’re doing a conversion. If you convert those funds to a Roth, you will have to pay taxes on the growth and deductible contributions that are being converted.

 

It’s usually a good strategy to pay the tax bill with non-IRA funds. Technically, you can withhold the taxes from the converted amount. However, to fully take advantage of the Roth’s benefits, you’ll want to fund it with as much money as possible. If you don’t have other funds to pay the tax bill, you may want to rethink the conversion.

 

How will you invest your Roth assets?

 

When your converted funds enter the Roth, they usually come into the account as cash. This may be a good time to reassess your investment strategy and your allocation. If you’ve recently retired, or if you’re approaching retirement, you may want to consider strategies that minimize risk while still providing growth opportunities.

 

One such strategy may be a fixed indexed annuity. These types of annuities pay interest based on the performance of an underlying index, like the S&P 500. If the index performs well, you receive a higher interest rate. If the index performs poorly, you receive less interest, but you never lose money.


Are you thinking about how to reduce your taxes in retirement? A Roth conversion may be one way to do so. Let’s discuss it. Contact us today at Bridgeriver Advisors LLC. We look forward to connecting with you and helping you develop a sound retirement strategy.

 

 

This information is designed to provide a general overview with regard to the subject matter covered and is not state specific. The authors, publisher and host are not providing legal, accounting or specific advice for your situation. By providing your information, you give consent to be contacted about the possible sale of an insurance or annuity product. This information has been provided by a Licensed Insurance Professional and does not necessarily represent the views of the presenting insurance professional. The statements and opinions expressed are those of the author and are subject to change at any time. All information is believed to be from reliable sources; however, presenting insurance professional makes no representation as to its completeness or accuracy. This material has been prepared for informational and educational purposes only. It is not intended to provide, and should not be relied upon for, accounting, legal, tax or investment advice.

16111 - 2016/9/20

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