Can a Roth Conversion Help You Achieve Your Retirement Goals?

As you approach retirement, strategic planning around your taxes can significantly impact your financial comfort and security during your golden years. One strategy that can be particularly advantageous is a Roth conversion, especially if you currently exceed the income threshold for contributing to a Roth IRA. 

Converting all or a portion of your tax-deferred accounts into a Roth IRA can offer tax-free growth and withdrawals in retirement. It can also help you avoid required minimum distributions (RMDs), which can increase your taxable income later in life. 

While a Roth conversion can be a valuable tax planning tool, maximizing its potential benefits requires an understanding of its intricacies and the broader tax landscape. In this blog article, we’ll explore what this strategy entails and its financial planning implications, so you can better assess whether a Roth conversion might help you reach your retirement goals more efficiently.

What is a Roth Conversion?

A Roth conversion involves transferring savings from tax-deferred accounts like a traditional IRA or 401(k) to a Roth IRA. Unlike traditional IRA contributions that may reduce your taxable income in the year they’re made, converting these funds to a Roth IRA requires you to pay income taxes on the converted amount in the year you make the conversion.

For instance, by moving your tax-deferred retirement savings to a Roth account, your funds can grow tax-free indefinitely. In addition, withdrawals are tax-free provided you’re at least 59 ½ years old and the account has been open for at least five years. 

A Roth conversion can be particularly advantageous for those who anticipate being in a higher tax bracket in retirement. It can also be an attractive option for those seeking to diversify their tax exposure or maximize their financial flexibility in retirement.

Benefits of Roth Conversions 

The strategic allure of Roth conversions lies in their ability to provide tax diversification. By having funds in both tax-deferred and tax-exempt accounts, you can better manage your tax liabilities in retirement. 

This feature allows for a range of benefits, including: 

• Flexibility in Withdrawal Strategies. By distributing investments across tax-deferred and tax-exempt accounts for strategic withdrawals, you can minimize the tax impact based on your current income level.
• Mitigating Risk of Future Tax Rate Increases. Locking in current tax rates on Roth can help protect against potential future tax increases.
• Reducing Required Minimum Distributions (RMDs). Since Roth IRAs don’t have RMDs, you can potentially lower your taxable income in retirement. This also offers estate planning benefits, as you can transfer a larger balance to your heirs if you don’t need to access your Roth IRA funds in retirement.

Considerations Before Initiating a Roth Conversion

A Roth conversion is a significant financial decision with both immediate and long-term implications. It’s important to understand the tax implications of this strategy and how it aligns with your long-term financial and retirement goals before proceeding. 

The first step is to decide how much money you want to convert. In general, this decision depends on several factors:

• Tax Implications. Converting to a Roth IRA means paying income taxes on the converted amount in the year of the conversion. You’ll want to consider how this additional income affects your tax bracket and total tax liability.
• Future Tax Rates. If you believe your tax rate will be higher in retirement, converting now might save you on taxes in the long run.
• Available Cash to Pay Taxes. Since the conversion adds to your taxable income, you’ll want to have enough cash on hand to cover the tax bill without dipping into the retirement funds you’re converting.

Another potential consideration is the timing of the conversion, which can impact your tax liability, as well as your potential investment appreciation over the long run. 

For instance, converting funds in years where your income is lower than usual can minimize the tax rate that applies to the conversion. On the other hand, converting in high income years could affect your Medicare premiums and the taxation of Social Security benefits if you’re already in retirement. 

Meanwhile, converting when the market is down can allow you to move more shares into a Roth IRA, potentially reaping greater tax-free gains when the market recovers.

Keep in mind there are no limits to the number of conversions you can undertake over time. This aspect of Roth conversions offers a range of strategic possibilities for managing your retirement funds and tax liabilities.

TrueNorth Wealth is here to help.

A Roth conversion can be a powerful tax planning tool, but it’s important to carefully weigh the benefits against the potential drawbacks within the context of your personal financial situation. If you’re looking for personalized retirement and tax planning guidance, TrueNorth Wealth is here to help. Our team of fiduciary CFP® professionals can help you develop a comprehensive plan that’s aligned with your current financial needs and longer-term goals. 

TrueNorth Wealth is among the top Wealth Management firms in Utah and Idaho, with offices in Salt Lake City, Logan, St. George, and Boise. At TrueNorth Wealth, we focus on helping our clients build long-term wealth while maximizing the enjoyment they receive from their money. We do this by pairing our clients with a dedicated CFP® professional backed by an incredible team.

For our team at TrueNorth, it’s about so much more than money. It’s about serving families all across Utah and helping them achieve freedom and flexibility in their lives. To learn more or schedule a no-cost consultation, visit our website at TrueNorth Wealth or call (801) 316-1875.