Last Updated on October 6, 2020
IRA Financial’s Adam Bergman Esq. discusses Roth IRA conversions, why you should do them, how they work and the tax advantages of the Roth IRA.
In this Podcast
The Roth IRA may be most underappreciated and little known retirement plan out there. The tax benefits of the plan are enormous. Wouldn’t you like to not have to worry about taxes from your retirement account ever again? A Roth IRA does just that! All qualified Roth IRA distributions are completely tax free.
Traditional retirement plans are funded with pre-tax money. You receive an immediate tax break for your contributions and taxes are deferred until you withdraw during retirement. However, you pay taxes on everything – contributions, income and earnings. It’s great if you want that annual tax break, but not so much when you start taking funds out of the plan. This is where the Roth IRA conversion comes into play.
A conversion is taking those traditional funds and moving them into a Roth IRA. You do have to pay taxes, but that’s the last time you have to pay them. The conversion is actually quite easy. Your custodian will generally take care of most things. You simply have to tell them you wish to perform a conversion.
There are a couple things you need to consider. First, is how much you want to convert. You do not have to convert your entire traditional IRA to a Roth at once. If you have a large balance and convert all at once, you will take a huge tax hit. Remember, any amount you convert is considered earned income and is taxable at your current tax rate. In fact, your conversion may put you into a higher bracket. Ideally, you don’t want that to happen, so you can perform a partial conversion. The second important factor is to have the money on hand to pay the taxes. For example, if you convert $10,000 and have to pay 20% in taxes, make sure you factor that extra $2,000 in taxes.
Why convert? Obviously, the biggest benefit is tax-free income during retirement. Your withdrawals are tax-free only when you meet the two criteria. First, the Roth IRA must be open at least five years. Secondly, you must be at least age 59 1/2. As soon as these two things are met, all your withdrawals are sans tax! Further, Roth IRAs are not subjected to the required minimum distribution rules. Traditional plans start being distributed once the holder reaches age 72, whether he or she needs the funds or not. Roth IRA owners do not have to withdraw from the plan until they need to, or until it is passed to a beneficiary at death.
Conversions make a lot of sense for most individuals. After all, who doesn’t want tax-free money!
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Join us next episode as Mr. Bergman discusses the IRA custodian and why you need one, especially if you want to invest in alternative assets.