IRAs are a great way to put money away for the future. The benefits of a traditional IRA include a tax deduction for contributing (if you qualify for one). With a Roth IRA, you cannot take a deduction for contributions, but when you withdraw the money, both your original contributions and the earnings on your investments are tax-free.
Many people choose the Roth IRA for building their nest-egg, so their withdrawals will not be taxable in retirement. For those who want the benefits of a Roth IRA but who have built up savings in a traditional IRA, a Roth IRA Conversion is a potential strategy.
When is converting to a Roth IRA a good idea? The answer involves doing some long-term planning. While Roth IRAs are advantageous for people whose taxable income will be higher in retirement, converting money to a Roth IRA is a taxable event, and so a conversion can have a big impact on your tax bill. For example, say you have a $100,000 IRA and you convert it all to a Roth IRA. That $100,000 will be reported as taxable income on top of your regular income. That can boost you into a higher tax bracket and super-size your tax bill, potentially negating the benefits of the Roth.
What’s in It for You?
The top 3 benefits of converting traditional IRAs to Roth include:
1. Tax benefits: A Roth IRA conversion is most beneficial if you will pay little or no additional tax from the conversion. This can be achieved with careful tax planning. Once your money is in a Roth IRA, you will not have to pay taxes on any earnings your investments gain from this point forward.
2. Access to your money: Should an emergency occur and require you to take a withdrawal from a traditional IRA before the age of 59½, you will not only have to pay taxes on the money, but the IRS imposes a 10% penalty. If you take an early withdrawal from a Roth IRA, a tax bill or a penalty will not occur if the money you take out is from contributions not investment earnings.
3. Less age restrictions: Traditional IRA’s are subject to required minimum distributions (RMDs) starting at age 72. Even if you do not need it or it is down market, you must begin drawing funds from your account. Roth IRA’s do not require RMDs, allowing you to leave the money in as long as you want, so that it can grow over time.
What’s in It for Your Family?
Long term planning also includes considering the best way to pass your wealth down to your family. A Roth IRA conversion can benefit you and your heirs. Just as you can take tax-free distributions from your account, your beneficiaries will not have to pay taxes on the money should they inherit it.
Proper investment management is critical to your financial health today and in the future. The mission at Blankinship and Foster, a firm of San Diego Family Wealth Advisors, is to improve people’s lives by helping them make good financial decisions. We design and manage personalized diversified portfolios for our clients depending on their personal investment goals and philosophy.