BY SUZANE HAZLETT, MBA, CIMA®, CFP®
Introduced under the Taxpayer Relief Act 1997, the Roth Individual Retirement Account (IRA) is named after U.S. Senator William Roth. Roth IRA contributions are made with after-tax money and are not tax-deductible. The key benefit is that earnings within the account accumulate tax-free, and qualified withdrawals after years of growth are also tax-free. The catch is that not everyone is eligible to contribute to a Roth IRA due to annual income limits.
For those holding a traditional, pre-tax retirement account, a Roth conversion moves all or a part of your traditional pre-tax IRA to a Roth IRA. The conversion is a reportable and taxable transaction, and generally, amounts converted will be subject to your ordinary income tax bracket in the year converted.
Here’s why it can still make sense to convert:
- Your taxable income or tax rates in the current year are lower than those expected in future years.
- You want to pay taxes now so that if qualifications are met, beneficiaries can inherit from the Roth IRA tax-free.
- Conversion can create tax diversification in your retirement as Roth IRA distributions are generally tax-free, whereas traditional IRA distributions are taxable. A mix of taxable and tax-free income may allow for greater flexibility in future tax environments.
- Roth IRAs are not subject to required minimum distributions (RMDs).
- Roth IRA distributions do not affect the counted income for Social Security or Medicare.
- Implementing a Roth conversion while asset values are depressed could result in a lower tax bill for the securities rolled over in a down market. Any resulting appreciation due to a market rebound will grow in the tax-free Roth IRA.
- Roth IRA conversions may be done “in-kind” without selling the assets.
When implementing a Roth conversion, consider paying taxes from an outside source, allowing all of the converted funds to grow instead of withdrawing from the pre-tax account to pay taxes.
For earnings to be tax-free, converted funds must be held in the Roth IRA for five years, and distributions must occur after age 59 ½ or due to death, disability, or put toward a first-time home purchase. During your next conversation with your tax and financial advisors ask whether a Roth conversion may benefit you.
Suzanne Hazlett, MBA, CIMA®, CFP® is a Certified Financial Planner Professional and Certified Investment Management Analyst. HAZLETT WEALTH MANAGEMENT, LLC, is independent of Raymond James and is not a registered broker/dealer. Investment advisory services are offered through Raymond James Financial Services Advisors, Inc. Securities offered through Raymond James Financial Services, Inc., member FINRA/SIPC. 675 Sun Valley Road, Suite J1 + J2 Ketchum, Idaho 83340 208.726.0605. HazlettWealthManagement.com
