When you begin saving for retirement, and putting money into a retirement vehicle, one of the decisions you must make is whether you want to contribute on a Roth (Post-Tax) or Traditional (Pre-Tax) basis. Both types of accounts offer tax savings opportunities by allowing you to determine whether you should pay your taxes now, or in the future.
With a Traditional IRA, your contributions and earnings are tax deferred, until you start taking distributions at which point both contributions and earnings will be taxable. On the other hand, when you contribute to a Roth IRA, you pay the taxes on the contributions up front and never pay taxes again. Any growth and earnings in a Roth account are tax-free (if you meet the following criteria: age 59 ½ and 5-year holding period).
However, what if you have been contributing to a Traditional IRA for years, and feel that you could benefit from paying taxes on that money now, versus in the future when you are ready to start taking distributions? Roth conversions allow you to do this!
A Roth conversion allows you to convert your traditional/pre-tax money into Roth after-tax money. While there are income limits for contributing to a Roth IRA, there are no income limits for doing a Roth conversion.
Advantages to a Roth Conversion:
- Any contributions and earnings after the conversion will grow tax free.
- Contributions can be withdrawn free of tax and penalty at any time.
- There are no required minimum distributions for Roth IRAs.
Things to Consider with a Roth Conversion (potential disadvantages):
- When you convert money from traditional pre-tax to Roth, you will pay ordinary income taxes in the year you complete the conversion.
- There are strategies for doing Roth conversions. If you convert everything at once, you could end up having a hefty tax bill.
- Even if you’re 59 ½, you will have to wait for the account to be open for five years before you can begin taking completely tax-free withdrawals.
How will you be taxed?
The amount of money that is being converted from Traditional to Roth will be taxed as ordinary income, and if you are not careful, you could end up being pushed into a higher federal income tax bracket. The conversion amount is added to your income when your tax return is filed for the year of the conversion.
Converting from Traditional Pre-tax may useful in developing your future retirement income strategy, and it requires a thorough evaluation prior to doing it. Consulting with a professional will help you avoid some potential pitfalls in doing it incorrectly.
If you are interested in learning more about Roth conversions, consider consulting your tax advisor and speaking with one of Tycor’s advisors for assistance. Contact us at 610-251-0670 or by EMAIL. Or simply provide your name and email address via our CONTACT FORM -- and we will reach out to you!