adding a roth IRA to your financial plan

Could You Benefit from a Roth IRA Conversion? Your Roth IRA Conversion Checklist

Roth IRAs are a powerful way to accumulate wealth and boost your retirement savings. Unfortunately, not everyone qualifies for a Roth IRA, but there may be a workaround!

If you’re aware of the power a Roth IRA has in your retirement plan but also know you don’t qualify for this type of retirement account, this article is for you! At Foran Financial Group, we’ve put together this Roth IRA conversion checklist to show you how you can harness the benefits a Roth IRA provides!

With a Roth IRA, once you pay taxes on your initial contributions, you get to enjoy tax-free growth and withdrawals in retirement. However, as of 2021, you have to make less than $125,000 as a single filer or $198,000 as a married couple filing jointly to contribute the full $6,000 to a Roth IRA. Limits begin to phase out for those who make between $125,000 and $140,000 as a single filer or $198,000 and $208,000 as a joint filer. If your income is above these limits, you’re not eligible at all.

This begs the question: What do you do if you’re a high-income earner but still want to enjoy the tax benefits of a Roth IRA? How do you get around these limits? The answer is with a Roth IRA conversion.

What is a Roth IRA Conversion?

A Roth IRA conversion occurs when you roll over assets from a Traditional IRA into a Roth IRA. It’s also sometimes referred to as a backdoor Roth IRA.

This is an excellent workaround if your income is too high to contribute directly to a Roth IRA. But there are trade-offs to consider.

Because you fund a Traditional IRA with pre-tax dollars and a Roth IRA with after-tax dollars, you’re required to pay taxes on any assets you convert upfront. But afterward, your money grows tax-free.

Example of a Roth IRA Conversion

Let’s say you’re a married couple, filing jointly. You and your spouse have $125,000 in taxable income. You could convert up to $47,750 of your Traditional IRA into a Roth IRA without getting bumped into a higher tax bracket. (The 22 percent marginal tax bracket for 2021 is $81,051 to $172,750.)*

When Would You Consider a Roth Conversion?

A Roth IRA conversion may sound like a great idea overall, but how do you know if one is right for you?

The main question to ask yourself is: Are the taxes I’d pay on this rollover now less than what I’d pay in the future? If the answer is yes, a Roth conversion may be a no-brainer.

Here are a few more examples of when you might want to consider a Roth IRA conversion:

  • You have a large Traditional IRA and expect your future tax bracket to be the same or higher in retirement.
  • You want to reduce Required Minimum Distributions (RMDs) on your Traditional accounts because you won’t need the full balance in retirement.
  • Your income is unusually low one year (possibly because of a job loss or furlough) and you want to capitalize on the tax savings.
  • Your account balance has dropped due to poor market performance, so you want to convert now before shares start ticking back up. This reduces your tax hit and gives you more bang for your buck.

When Wouldn’t You Consider a Roth Conversion?

There are also several situations where you may not want to do a Roth IRA conversion, such as:

  • You’re already in a high tax bracket or suspect a Roth IRA conversion would bump you into an even higher one.
  • You suspect you’ll be in a lower tax bracket in retirement. If your income tax bracket is lower, you’ll save more money by paying taxes on your account then, opposed to now.
  • You don’t have enough savings to cover the conversion tax.

When you do a conversion, the IRS wants you to pay the taxes immediately as a quarterly estimated payment. Taking this money from your retirement account significantly reduces its balance and limits its growth potential, so it’s recommended to cover this bill with other funds.

Benefits of a Roth IRA Conversion 

There are a lot of benefits to doing a Roth IRA conversion. Here are a few:

You Can Save on Taxes

Perhaps the biggest benefit of a Roth IRA conversion is the tax-free growth you’ll get to enjoy in retirement.

Here’s an example of just how powerful this tax-free growth can be:

Let’s say you do a Roth IRA conversion for $45,000. You pay taxes on this money upfront, relative to your current tax bracket.

Now let’s say you let that $45,000 grow for 30 years. Assuming a 6 percent annual rate of return, your account would be worth almost $260,000 – that’s $215,000 in growth you won’t pay a single penny on in retirement!*

You Have Higher Contribution Limits 

Traditionally, you can’t contribute more than $6,000 a year to an IRA if you’re under age 50, or $7,000 a year if you’re 50 and older. However, these limits don’t include rollovers. When you do a Roth IRA conversion, you can transfer as much money as you want without worrying about hitting any limits (although you should still be mindful of your tax bracket).

There are No RMDs

You’re legally required to start taking RMDs from your tax-deferred retirement accounts once you turn age 72.

RMDs count as taxable income, which could inadvertently bump you into a higher tax bracket and subject you to higher Medicare premiums in retirement.

On the flip side, Roth IRAs aren’t subject to RMDs, because you fund them with after-tax money, so by converting funds into a Roth IRA, you reduce the amount of RMDs you have to take in retirement. Please note, if you are required to take a Required Minimum Distribution (RMD) in the year you convert, you must do so before converting to a Roth IRA.

For other age-based retirement decisions you should be aware of, read our recent blog post: Your Relationship with Money: Important Ages to Keep in Mind.)

There are Estate Planning Benefits

RMDs are based on life expectancy and are designed to bring your account balance close to $0 by the time you pass away. This means that, unless you pass away much sooner than expected, there’s a good chance you’ll have little money left in that account to pass on to your heirs.

By converting funds into a Roth IRA, you can let it continue to grow and build throughout your lifetime. Then, you can leave the entire amount to your heirs.

Warning: Roth IRA Conversions Can’t Be Undone

As of January 1, 2018, Roth IRA conversions cannot be recharacterized, meaning, they can’t be reversed. As a financial advisor in New Jersey, I see a lot of DIY investors do a conversion on their own, only to realize they are hit with a larger tax bill than expected, and there’s no way to undo it. The damage is done.

That’s why it’s so critical to review your situation to make sure it’s the right move for you. This type of scrutiny often requires the experienced eye of a financial advisor to get right.

At Foran Financial Group, our financial advisor team in New Jersey has helped countless individuals save on taxes through Roth IRA conversions. If you have any questions about your specific financial situation, or would like help deciding if a Roth conversion is right for you, contact me directly. I’d love to help you strive to be on track for a secure retirement.

Remember, retirement planning is important, especially in New Jersey! Don’t put these important decisions off. Use this Roth IRA conversion checklist, and then contact us for a comprehensive review.

Foran Retirement Ready

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results.

A Roth IRA offers tax deferral on any earnings in the account. Qualified withdrawals of earnings from the account are tax-free. Withdrawals of earnings prior to age 59-½ or prior to the account being opened for five years, whichever is later, may result in a 10 percent IRS penalty tax. Limitations and restrictions may apply.

Traditional IRA account owners have considerations to make before performing a Roth IRA conversion. These primarily include income tax consequences on the converted amount in the year of conversion, withdrawal limitations from a Roth IRA, and income limitations for future contributions to a Roth IRA. In addition, if you are required to take a Required Minimum Distribution (RMD) in the year you convert, you must do so before converting to a Roth IRA.

This information is not intended to be a substitute for specific individualized tax advice. We suggest that you discuss your specific tax issues with a qualified tax advisor.

*This is a hypothetical example and is not representative of any specific investment. Your results may vary.