Tax Planning with Strategic Roth Conversions
The safest and surest way to climb a truly big mountain is to halve the load and cache stores of food and fuel deep in the snow between advancing camps for later retrieval. This caching system helps the mountaineer climatize, but it also distributes the weight for a more methodical progression up the mountain, and evades the risk of getting caught in a blizzard carrying 130 pounds of gear, or getting buried under it in a crevasse. Many Americans store the vast majority of their retirement capital in traditional, “yet to be taxed”, accounts, like 401(k)’s, 403(b)’s, and IRA’s, thereby consolidating the period of taxation on all future, fully taxable distributions exclusively to their retirement years. Consider the process, implications, and benefits of strategic Roth Conversions as you thoughtfully distribute the weight of planning your own retirement.
The process:
Dollars converted from traditional retirement accounts to a Roth Conversion account are taxed as income in the year of conversion.
Conversions should be accomplished by direct transfer, as opposed to rollover, to avoid penalties for improper procedure. In other words, never have a Roth Conversion check made out to you.
The implications:
Be sure to know the rates at which converted dollars will be taxed by the Federal government and the state. A small amount of tax planning is involved in every Roth Conversion, so do the work.
Concentrate conversions to ‘lower-than-average’ income years, especially those between partial retirement and when required minimum distributions (RMD’s) begin, “filling-up” the associative lower brackets with partial conversions. This will maximize income taxed at lower tax rates, a smart move!
If you are under age 59½, be sure to pay the tax on a Roth Conversion from savings, not from the IRA, which would involve an early distribution penalty and defeat the purpose. Try to always pay Roth Conversion taxes from savings, as this will place more dollars in the Roth account growing tax free.
The benefits:
Distributions from Roth Conversion accounts are tax free.
Roth Conversion accounts have no RMD’s, so all conversions effectively reduce traditional retirement assets and future RMD amounts.1 This is especially beneficial to retirees in high tax brackets, and those who are forced to take RMD’s they don’t need.
Roth Conversions, though taxed at the estate tax level, can be left to heirs income tax free. The Secure Act now requires full (tax free) distribution by non-spousal beneficiaries within 10 years. Educate your beneficiaries so they use the whole 10 years of continued tax free growth, and so they don’t miss the deadline for full distribution.
The cumulative benefit of strategic Roth Conversions to the wealth producer resembles that of the cache system to the mountaineer. Never allow a highly beneficial Roth Conversion opportunity to pass you by!
Think about it, Shaun.
“The prudent sees danger and hides himself, but the simple go on and suffer for it.” ~Proverbs 2:3
1 Smart Money Minute, “How to Minimize Your Taxes on a Roth Conversion”, October 5, 2023
The opinions voiced in this material are general, are not intended to provide specific recommendations, and do not necessarily reflect the views of LPL Financial.
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.
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