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When Does It Make Sense to Do Roth Conversions? Thumbnail

When Does It Make Sense to Do Roth Conversions?

Financial Planning

Understanding Roth Conversions 

A Roth conversion involves transferring funds from a traditional IRA or other tax-deferred retirement accounts into a Roth IRA. Unlike traditional IRAs, Roth IRAs allow your investments to grow tax-free, and qualified withdrawals during retirement are also tax-free. This makes Roth IRAs a compelling option for long-term tax planning and retirement strategies. 

Mechanics of Roth Conversions 

The process of a Roth conversion is relatively straightforward but has significant tax implications. When you convert funds to a Roth IRA, you must pay income taxes on the amount converted. This is because contributions to traditional IRAs are typically made with pre-tax dollars, meaning you haven’t paid taxes on that money yet. By converting these funds to a Roth IRA, you effectively choose to pay taxes now rather than later. The converted amount is added to your taxable income for that year, which could potentially increase your tax bracket. 

When Is a Roth Conversion Beneficial? 

Low-Income Years 

A Roth conversion can be particularly advantageous during years when your income is lower than usual. This could occur during a job transition, a sabbatical, or early retirement before you start receiving Social Security benefits. Converting during these low-income years allows you to pay taxes at a lower rate, thereby minimizing the tax impact of the conversion. At Seaside Wealth Management, we refer to these years as your “Gap Years” and love to do conversions during these years. 

Pre-Retirement Strategy 

Converting to a Roth IRA before you start taking required minimum distributions (RMDs) from your traditional IRA, which are mandated at age 73 (or 75 if born before 1960), can be beneficial. RMDs can significantly increase your taxable income, so by converting earlier, you reduce the balance in your traditional IRA and lower the amount of your future RMDs. By taking a multi-decade approach to tax planning, you can reduce your overall lifetime tax liability significantly. 

Anticipated Higher Future Tax Rates 

If you expect that your tax rate will be higher in the future (and we sure do), either due to personal income growth or changes in tax legislation, it makes sense to pay taxes now at a lower rate. This forward-thinking strategy can result in substantial tax savings over the long term. 

Estate Planning Considerations 

Roth IRAs can play a crucial role in estate planning. Unlike traditional IRAs, Roth IRAs do not require RMDs during your lifetime, allowing the account to grow tax-free for a more extended period. This can be particularly advantageous if you want to leave a tax-free inheritance to your beneficiaries. They can inherit the Roth IRA and continue to benefit from tax-free growth and withdrawals, making it a powerful tool for wealth transfer. 

Benefits of Roth Conversions 

One of the most significant benefits of a Roth IRA is the ability for your investments to grow tax-free. This can result in substantial tax savings over the years, especially if you expect your investments to perform well. Additionally, the absence of RMDs for Roth IRAs means you can allow your money to grow tax-free for as long as you live, providing more flexibility and control over your retirement funds. 

Another advantage is the flexibility in managing your taxable income during retirement. With tax-free withdrawals from a Roth IRA, you can strategically manage your income to stay in a lower tax bracket, potentially reducing taxes on your Social Security benefits and other sources of income. 

From an estate planning perspective, Roth IRAs offer considerable benefits. They allow you to pass on tax-free income to your heirs, providing them with financial security and minimizing their tax burden. This makes Roth IRAs a valuable component of a comprehensive estate plan. 

Why Consider a Roth Conversion Now? 

The decision to convert to a Roth IRA should be based on a thorough analysis of your current and future tax situation, your retirement goals, and your overall financial plan. Factors such as your current income, anticipated future income, expected rate of return on investments, and estate planning goals all play a role in determining whether a Roth conversion is the right move for you. 

If you’re considering a Roth conversion or have questions about whether it makes sense for your financial situation, reach out to us today. Your future self will thank you. 

This commentary reflects the personal opinions, viewpoints and analyses of the Seaside Wealth Management, Inc. employees providing such comments, and should not be regarded as a description of advisory services provided by Seaside Wealth Management, Inc. or performance returns of any Seaside Wealth Management, Inc. client. The views reflected in the commentary are subject to change at any time without notice. Nothing in this commentary constitutes investment advice, performance data or any recommendation that any particular security, portfolio of securities, transaction or investment strategy is suitable for any specific person. Any mention of a particular security and related performance data is not a recommendation to buy or sell that security. Seaside Wealth Management, Inc. manages its clients’ accounts using a variety of investment techniques and strategies, which are not necessarily discussed in the commentary. Investments in securities involve the risk of loss. Past performance is no guarantee of future results.