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Is A Roth Conversion Right For You?

Is A Roth Conversion Right For You?

If you're approaching retirement age, have you taken the time to evaluate your expected tax liability from various income sources for the next 30 years or more? For many, the window after retirement and before beginning Social Security or taking required minimum distributions creates an opportunity for Roth conversions. For most people, this tax hedge saves thousands of dollars over their lifetimes. 

A Roth conversion involves transferring funds from a traditional Individual Retirement Account (IRA) to a Roth IRA. Unlike traditional IRAs, which offer tax deductions on contributions, Roth IRAs provide tax-free distributions in retirement. By converting your traditional IRA to a Roth IRA, you can take advantage of tax-free growth and potentially reduce your tax burden in the future.

Before diving into the details, it's important to note that Roth conversions have certain rules and implications. To make an informed decision, let's explore the benefits of converting your IRA to a Roth IRA.

Benefits Of Converting Your IRA To A Roth IRA

  1. Tax-free growth: One of the most significant advantages of a Roth IRA is tax-free growth. When you contribute to a traditional IRA, you receive a tax deduction upfront, but the IRS taxes those dollars upon withdrawal. With a Roth IRA, your contributions are made with after-tax dollars, meaning your earnings grow tax-free, and withdrawals in retirement are also tax-free.
  2. No required minimum distributions (RMDs): Traditional IRAs require you to start taking mandatory distributions once you reach the age of 72 (or 75 if you were born in 1960 or later). The account's value on December 31 in the year prior to the RMD determines these required minimum distributions (RMDs), which are calculated using the Uniform Lifetime Table in IRS Publication 590-B (https://www.irs.gov/pub/irs-pdf/p590b.pdf). With a Roth IRA, RMDs are not required during your lifetime, allowing your investments to grow tax-free for as long as you wish.
  3. Flexibility in withdrawals: Another advantage of a Roth IRA is the flexibility it offers in withdrawals. Since you've already paid taxes on your contributions, you can withdraw your original contributions at any time without incurring penalties or taxes. This added flexibility can be particularly helpful in emergencies or when unexpected expenses arise.

Tax Consequences Of Roth Conversions
The process is relatively straightforward once you determine that converting your IRA to a Roth IRA is in your best interest, but be sure to evaluate your decision's tax ramifications before executing. You may want to seek guidance from a qualified financial or tax advisor to help assess your specific circumstances, provide personalized advice, and help you navigate the process. 

To calculate the taxes due, use a Roth conversion calculator or consult with a tax professional to estimate the taxes you'll owe upon conversion. When you convert your traditional IRA to a Roth IRA, the converted amount is treated as ordinary income in the year of the conversion. You'll owe federal taxes on the converted amount at your current tax rate, and depending on the state you live in, you may also owe state taxes.

When considering a Roth conversion, assessing your current and projected future tax rates is crucial. If you expect your tax rate to be higher later in retirement, converting to a Roth IRA may be beneficial. However, if you anticipate a lower tax rate in the future, it may be more advantageous to stick with a traditional IRA.

If the converted amount pushes you into a higher tax bracket, you may experience a loss of tax deductions. Retirees already taking Social Security may experience a higher percentage of their benefits becoming taxable. 

While a Roth conversion may result in immediate tax payments, it can provide long-term tax savings. With tax-free growth and tax-free withdrawals in retirement, a Roth IRA can help you minimize taxes over the long run.

Understanding the tax implications is vital when deciding whether a Roth conversion suits your financial situation. 

Additional Factors To Consider Before Converting Your IRA to a Roth IRA
While a Roth conversion can be advantageous for many individuals, it's important to evaluate your circumstances carefully. Before deciding to execute the Roth conversion, consider your time horizon and available cash to pay taxes due. 

Time Horizon: The longer your time horizon, the more time your investments have to grow tax-free within a Roth IRA. If you have many years until you need to withdraw from this account, a Roth conversion can yield significant tax savings in the long run.

Availability of cash to pay taxes: When you convert your traditional IRA to a Roth IRA, you'll owe taxes on the converted amount. It's best to cover these taxes with outside funds. If you need to withdraw cash from your IRA to pay the taxes, it may diminish the benefits of the conversion.

Frequently Asked Questions About Roth Conversions
Do you need to convert your entire IRA? Contrary to popular belief, you are not required to convert your entire traditional IRA to a Roth IRA. Partial conversions allow you to convert only a portion of your IRA that aligns with your financial goals. You may also convert a portion of your Traditional IRA for several consecutive years. 

Are Roth conversions allowed for high-income earners? While income restrictions previously limited high-income earners, removing these limitations in 2010 allowed anyone to benefit from a Roth conversion.

Can you convert if you're retired? While making contributions to Roth IRAs require earned income, you can convert to a Roth IRA in retirement. In fact, your retirement status would likely improve your ability to convert your Traditional IRA to a Roth IRA because you are probably in a lower tax bracket than during your working years. 

Seeking Professional Advice For A Roth Conversion
Deciding whether to convert your IRA to a Roth IRA is a complex financial decision that requires careful consideration. Seeking professional advice from a financial advisor can provide you with the expertise and guidance needed to make an informed choice. 

The fiduciary financial planners at Hurlow Wealth Management Group have assisted clients with Roth conversions and other tax mitigation strategies for over two decades. With their comprehensive knowledge of retirement planning and tax implications, they can help you navigate the complexities of a Roth conversion. Schedule an introductory call today.

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Services offered through Hurlow Wealth Management Group, Inc., a Registered Investment Adviser. Hurlow Wealth Management Group, Inc. does not provide tax, legal or accounting advice. Advisory services are only offered to clients or prospective clients where Hurlow Wealth Management Group, Inc. and its representatives are properly licensed or exempt from licensure. Past performance is no guarantee of future returns. Investing involves risk and possible loss of principal capital. No advice may be rendered by Hurlow Wealth Management Group, Inc. unless a client service agreement is in place.
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