Converting your traditional IRA or 401(k) to a Roth IRA allows you to enjoy tax-free withdrawals in retirement. While Required Minimum Distributions (RMDs) come into play with traditional IRAs or 401(k)s once you turn 72, that’s not the case with Roth IRAs. There are no RMDs, and any withdrawals you make are tax-free for the rest of your life.
There are three main times in which doing a Roth conversion is a good idea:
The sweet spot for a Roth conversion for many clients is between the time they retire and when they start taking Social Security. That’s a window in which they have little income and the time is ripe for a Roth conversion.
Life might hand you lemons if you get laid off. But you can make some lemonade out of this experience by opting to do a Roth conversion. This is when you’re taking advantage of tax brackets because your job loss puts you in a lower bracket temporarily.
When the markets drop significantly, it takes a toll on your account balances and your emotional state. The bright side is that by doing a Roth conversion, you’re moving the discounted shares into your Roth IRA. You must pay tax on the pre-tax shares when you convert, but you're paying a lot less than if you converted before the market fell. When the market rebounds, any withdrawals are now tax-free.
Although you can do a Roth conversion at any age, keep in mind that once you are 72 or older, you must take RMDs before converting.
The right time to do a Roth conversion depends on a number of factors, which can include your current tax rate versus your protected future rate, the size of the tax bill you’ll pay for the conversion, amongst others. If your tax bracket is higher now than when you start making withdrawals, you could end up paying more in taxes due to the conversion than you would save making later tax-free withdrawals.
When a client is considering a Roth conversion, a financial planner at EP Wealth Advisors will first perform a robust analysis of the previous year’s tax return. We’ll look at all components, including federal, state, and Medicare taxes to see how they will impact the client. For instance, your income affects your Medicare premium. By converting just the right amount of pre-tax retirement funds, you can avoid paying more for Medicare.
There are circumstances in which you should think twice about doing a Roth conversion. For example, if you don’t have the cash available to pay the tax bill on the conversion, you could end up paying the tax out of the converted balance. That means less money for tax-free growth.
If you need to tap your Roth IRA money within the next five years after opening the account, you could pay a penalty. The five-year rule pertaining to Roth IRAs begins as of January 1 of the year in which you made the initial contribution.
To discuss your retirement planning options and investment management strategies, contact a financial professional at EP Wealth Advisors today.
Disclosures:
EP Wealth Advisors, LLC (“EP Wealth”) makes no representations or warranties as to the accuracy, timeliness, suitability, completeness, or relevance of any information presented in this report. EP Wealth has used its best efforts to verify the data included in this report. The information presented was obtained from sources deemed to be reliable. However, EP Wealth cannot guarantee the accuracy or completeness of the information offered. All expressions of opinion are subject to change without notice.
The content of this report is believed to be accurate as of the date of publication and cannot and does not accurately forecast future economic, market, or financial conditions; including changes to retirement benefits, social security, and/ or Medicare. For this reason, any subsequent changes, and/or that occur after the publication of this presentation may cause the analysis encompassed herein to become inaccurate. Any references to future market or economic forecasts are based on hypothetical assumptions that may never come to pass.
The information presented here is not intended to be regarded as a comprehensive list of considerations, including but not limited to, categories, services, or qualifications that a client or prospective client should consider when assessing or comparing Financial Advisors and/or Firms. As the author of this piece, EP Wealth Advisors, LLC (“EPWA”) has tailored the messaging of this article to align with the categories, services, qualifications, capabilities and services that it offers. There is no guarantee or warrantee that the services offered by EPWA will satisfy your financial services requirements. Services offered by other advisors may be more suitable to your specific needs.
There is no guarantee nor is the intention of this publication to establish any sense of assurance, that, if followed, the strategies referenced here will produce a positive or desired outcome. In fact, there is no guarantee that any of the steps detailed will enable the ability to generate successful or appropriate strategy or approach. The intent of this article is strictly for educational purposes.
The need for a financial advisor or financial planner and/or the type of services required are specific to the uniqueness of each individual’s circumstances. The referenced material identified herein is limited in nature and specific to what is offered by EPWA. There is no guarantee or warrantee that the services offered by EPWA will satisfy your financial services requirements. Services offered by other advisors may be more suitable to your specific needs.