Is It A Good Time To Convert To Roth?

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Is Your Traditional IRA or 401(k) Down in Value This Year? Many financial experts are telling it a good time to convert to a Roth because you can pay taxes on a lower account value, and when the market corrects, your money can grow tax-free. However, here are some reasons why it might not actually be a good time for a Roth conversion:

1) You need to withdraw money from your retirement account to pay taxes. If you have to pay taxes with the money withdrawn from the account, it usually doesn’t make financial sense because that money will no longer grow for your retirement. This is of even greater concern if withdrawals are subject to a 10% early withdrawal penalty. Ideally, you would pay taxes with money outside the retirement account.

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2) You’ll pay a lower tax rate in retirement. This can be a difficult task because the tendency is to compare your current tax bracket with what you expect to be in retirement. However, some things should be kept in mind. One is that the conversion itself can push you into a higher tax bracket.

The second is that when you eventually withdraw money from your non-Roth retirement account, it won’t be taxed at all at that rate. Let’s take an example where you retire this year with a combined income of $120k. Since some of your income will not be taxed at all due to deductions, your taxable income cannot exceed $100k. This puts you in the 22% tax bracket.

However, only the first $20,550 of your taxable income will be taxed at 10%. Then everything up to $83,550 from there is taxed at 12%. Only income over $83,550 is taxed at a 22% rate. As a result, someone with $100k of taxable combined income in retirement may be in the 22% bracket but pay only 13% of their taxable income in taxes. You can view your marginal tax bracket and effective tax rate Here,

3) You have a kid in college. A Roth conversion will increase your reported income and potentially reduce your child’s financial aid eligibility.

Of course, there are also situations where a Roth conversion makes sense:

1) You think your tax rate on withdrawals may be higher. You might not have worked or earned a lower income for at least part of the year, took more deductions than usual, or have other reasons for being in a lower tax bracket this year. Perhaps you’re getting a bigger pension or have other assets that will fill lower tax brackets in retirement. Maybe you’re concerned about increasing tax rates by the time you retire, or you may intend to pass that account on to heirs who may be in a higher tax bracket. In either of these situations, a Roth conversion lets you pay taxes on your account before the tax rate increases.

2) You have money to pay taxes outside of your retirement account. For example, let’s say you have $22k in a savings account, and you’re going to convert a $100k pre-tax IRA to a Roth IRA. At a 22% tax rate, a $100k pre-tax IRA is equivalent to a $78k Roth IRA. If you convert this and use the money outside the account to pay taxes, the $100k pre-tax IRA balance becomes the $100k Roth IRA balance, which equals a $22k “contribution” to the Roth IRA. Is.

If you had only invested $22k in a taxable account, you would have had to pay taxes on the income. By transferring the value to a Roth IRA, the income grows tax-free. it The calculator Helps you crunch your numbers.

3) You want to use the money for a non-qualified expense in 5 years or more. After you convert and wait 5 years, you can withdraw the amount you converted at any time and for any reason, without tax or penalty. Just be aware that if you withdraw any post-conversion income before age 59, you may face income tax and a 10% penalty tax.

4) You want to avoid Required Minimum Distributions (RMDs). Unlike traditional IRAs, 401(k)s and other retirement accounts, Roth IRAs are not subject to RMDs. This allows more of your money to grow tax-free for a longer period of time. If that’s your motivation, remember that as long as you can pay a lower tax rate, you can always wait to convert until you retire.

Want to make a Roth conversion but are worried about taking a tax deduction? Keep in mind that a Roth conversion doesn’t have to be a one-time event. You can make multiple conversions over several years and spread the tax impact over that time if you’re concerned about pushing your income into a higher tax bracket in a particular year.

There are good reasons to convert to a Roth and not to convert. Don’t just do what feels good or blindly follow what other people do. Instead, ask yourself if this is a good time for you based on your situation. If not, you can always convert when the time is right.

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