Roth IRA Conversions can Help Build Long-Term Wealth

How Do Roth Conversions help build wealth?

There are three ways Roth IRA Conversions help build wealth: One is by avoiding taxable Required Minimum Distributions, which begin at age 701/2 for traditional IRAs. Another is by allowing more of your money to stay sheltered from income taxes. And a third is by allowing your heirs to inherit Roth IRA assets, potentially extending the tax benefits for many years beyond your lifetime.

What’s so great about Roth IRAs?

Roth IRAs can be a wonderful ingredient in your retirement portfolio. Like traditional IRAs, dividends, interest and capital gains in a Roth IRA are sheltered from income taxes. However, unlike traditional IRAs, qualified withdrawals (withdrawals taken after a five year waiting period and after age 591/2) are tax-free, and there are no required withdrawals from Roth IRAs during the lifetime of the original owner. These differences make Roth IRAs ideal for funding the later years of retirement. And, as an added bonus, if you pass Roth IRA assets to your heirs, they can continue the tax-free growth and tax-free withdrawals.

Roth IRA Conversions from Traditional IRA assets

The problem with Roth IRAs, for many investors, is not being able to put money into them. Contributions to Roths are not allowed for those with incomes above certain limits. However, anyone can “convert” a traditional IRA to a Roth IRA regardless of their income. Problem solved, right? No so fast. Converting your IRA can have a tax impact: any pre-tax IRA assets you convert to a Roth are taxable income in year of conversion. If you are in a high tax bracket, or if the additional income from a conversion will boost you into a higher tax bracket or income threshold (such as the Medicare tax), the increase in your tax bill may be too steep, and a conversion may not be worth the cost. But if your income is low, or if you have a lot of deductions or losses to offset your income, the tax impact may be reasonable. Luckily, it’s not an “all or nothing” decision—the IRS rules allow you to do partial conversions. This means you can choose to convert as much of your IRA as you and your tax preparer decide is reasonable.

The “Free Look” Reversal Provision

Are you wondering if a Roth IRA Conversion will create too much of a tax bill? Or what if the value of the converted assets drops after you have converted them? IRS rules allow you to “re-characterize” (reverse) part or all of the conversion after the end of the year, as long as it’s done before the filing date for your income tax return. This ability to reverse some or all of a conversion amounts to a “free look”; you can wait to see exactly what the tax effect will be, and undo it if it won’t benefit you—all without a negative effect.

Are Roth IRA Conversions right for you?

Roth IRA Conversions are best done as part of a comprehensive Retirement Income Plan that considers your current and expected income, taxes, and cash flow situation. Please Contact Us or your financial advisor to help you decide the best strategy for including Roth IRA Conversions in your plan.

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About Jon Beyrer

Jon Beyrer, EA, CFP® is a partner of Blankinship & Foster LLC and is the firm’s Chief Compliance Officer. As a lead advisor, he focuses on helping families achieve their goals with sound wealth planning. In the community, Jon serves on several boards and is co-founder of the Professional Alliance for Children, a legal/financial charity for families of ill children. He has been quoted in The Wall Street Journal, The New York Times, and the Journal of Financial Planning. Jon lives in San Diego with his family.

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