Is a Roth Conversion Right for You?
As you approach retirement, you may be considering a Roth conversion to optimize your tax strategy. But is it too late to make the switch?
Understanding the Rules
From a legal standpoint, you can transfer retirement funds from a tax-deferred account like a 401(k) to a Roth IRA at any age, including 69. However, it’s essential to weigh the pros and cons before making a decision.
The Benefits of a Roth Conversion
A Roth conversion allows you to transfer funds from a tax-deferred account to a Roth IRA, paying taxes now in exchange for tax-free withdrawals later. This strategy also exempts you from Required Minimum Distribution (RMD) rules, giving you more control over your retirement savings.
The Drawbacks
One major drawback is the need to pay income taxes on converted amounts, which can result in a significant current tax bill. Additionally, Roth conversions can limit your withdrawal flexibility, and you may face penalties for withdrawals taken within five years of the conversion date.
Predicting Future Tax Rates
With current income tax rates at historic lows, it’s challenging to predict whether rates will increase or decrease in the future. This uncertainty can make it difficult to determine the best time to convert.
A Gradual Approach
Many savers opt for a gradual conversion strategy, converting a portion of their funds each year to minimize the current tax impact. However, even smaller conversions can push you into a higher tax bracket and increase your Medicare premiums.
Case Study: Converting $815,000
Let’s consider an example: if you’re a single filer with $100,000 in taxable income and $815,000 in your 401(k), converting the entire amount at once would put you in the top 37% federal income tax bracket. By spreading the conversion over four years, you can reduce the tax burden and preserve some flexibility for later tax management.
Seeking Professional Guidance
A financial advisor can help you navigate the complexities of a Roth conversion and determine the best approach for your individual situation. They can also help you model the potential tax impacts of future financial moves and create a tailored strategy to achieve your goals.
Getting Started
If you’re considering a Roth conversion, don’t hesitate to seek professional guidance. SmartAsset’s free tool can match you with up to three vetted fiduciary advisors in your area. Take the first step towards optimizing your retirement savings today.
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