Updated February 8, 2022 by John Posey
If you or your spouse have traditional retirement plans like 401(k)s or IRAs and you’re nearing or in retirement, a Roth IRA conversion might be worth considering. Traditional retirement accounts are funded with pre-tax dollars, meaning you will pay ordinary income tax on the funds as you withdraw them. Roth IRAs are different in the fact that they are funded with post-tax dollars (you receive no tax deduction for the contribution) and withdrawals are tax-free beyond age 59 ½ if the Roth IRA has been established for five years or more. It would be wise to talk with your accountant about this idea.
Periodic Roth conversions could lower your tax bill
If you or your spouse rocked the cradle so to speak, the potential benefits could be even more significant for you. A surviving spouse will eventually have to file as a single taxpayer where the tax brackets are reduced, more easily subjecting them to higher tax rates. It may make sense to do Roth conversions over time where you take funds from your traditional, pre-tax IRA, realize the amount you convert as income, pay the tax (ideally with non-retirement funds) and contribute those funds to a Roth IRA. Presumably with both spouses alive filing as joint filers and realizing some of your pre-tax retirement funds as income each year, your ultimate tax liabilities could be lower over time using this strategy. The idea would be to realize income each year from completing Roth conversions to a point that does not adversely affect your current tax situation. It’s best to coordinate this kind of strategy with your tax professional.
No required minimum distributions
Roth IRA funds are not subject to minimum required distributions as standard with most traditional retirement accounts starting at age 72.
Your heirs receive Roth IRA funds tax-free
Distributions after death from a Roth IRA are not taxed to your heirs. Conversions can be particularly beneficial if your heirs are in a higher tax bracket than yourself which is often the case as you work less or fully retire. Heirs can also elect to leave inherited Roth IRA funds in an inherited Roth IRA account for up to 10 years (from the original owner’s death) which can amplify the tax-free growth and earnings potential.
Opportunistic timing of a conversion could result in tax savings
The best time to consider a Roth conversion is when your retirement accounts are experiencing a decline in value. You will pay ordinary income tax on the value you choose to convert, however, if those values are coming from securities that declined in value and you intend to stay invested in them to recover value and grow over time, you essentially pay tax on those assets at a lesser value than you may have otherwise. Plus, those assets will get the opportunity to grow tax-free in the Roth IRA. Of course, there is no reliable or consistent way to optimally time a Roth conversion, but if the opportunity arises to convert while values are down you’d be wise to consider it. Read, It's Roth IRA Conversion Season, for a real-life example.
If you’re close to or in retirement, take a look at this idea. It might save you some hard-earned dollars throughout your retirement.
Advisory services offered through Plains Advisory LLC, an investment adviser registered with the State of Nebraska. Insurance products and services are offered and sold separately through John Posey, a licensed insurance agent. No investment strategy can guarantee a profit or protect against loss in periods of declining values. Opinions expressed are subject to change without notice and are not intended as investment advice or to predict future performance. Past performance does not guarantee future results. Any information provided is designed to provide general information on the subjects covered, it is not, however, intended to provide specific legal, tax, financial or investing advice and cannot be used to avoid tax penalties or to promote, market, or recommend any plan or arrangement. Material presented is believed to be from reliable sources and no representations are made by our firm as to another parties’ informational accuracy or completeness. All information or ideas provided should be discussed in detail with an advisor, accountant or legal counsel prior to implementation.