We all want to maximize our hard-earned retirement savings. The best way to do this is by converting your qualified retirement savings plan to a Roth IRA. And to do it now. Here are a list of reasons why converting now is the way to go:
You want tax-free withdrawals in retirement
When taking withdrawals from a traditional IRA, you’d have to pay taxes on the money your investments earned—and on any contributions you originally deducted on your taxes. With a Roth IRA, as long as you meet certain requirements, all of your withdrawals are tax-free.
You need to access the money early
While regular IRAs and 401(k) accounts generally come with a 10% penalty if you withdraw money before age 59½, the rules are slightly different for Roth IRAs. Direct contributions — which are after-tax — can be withdrawn at any time penalty-free. The earnings, though, must remain untouched to avoid the penalty (and taxes).
For money that’s converted to a Roth IRA, you can avoid the penalty as long as you leave it alone for five years. As with direct contributions, however, the earnings remain off-limits until age 59½ or you’ll pay the 10% penalty and taxes.
You expect future tax rates to be higher
In this scenario, paying taxes at your current tax rate is preferable to paying a higher rate after you’ve stopped working. Paying higher taxes in retirement is inevitable, especially if you haven’t yet hit your peak earning years or you’ve accumulated significant savings in your retirement accounts. It makes sense to convert all or a portion of funds in a traditional IRA to a Roth now and lock in the lower tax rate on your savings.
You have irregular income streams and lower than usual income this year
Suppose you own a business that generated a net operating loss from non-passive income. This could be the perfect opportunity to convert some funds to a Roth IRA with a relatively low tax impact.
You want your money to grow tax-free for longer
Traditional IRAs force you to take required minimum distributions (RMDs) every year after you reach age 72, regardless of whether you actually need the money. You pay taxes on these distributions. This means you lose the tax-free growth on the money you had to withdraw. On the other hand, Roth IRAs don’t have RMDs during your lifetime, so your money can stay in the account and keep growing tax-free.
You want to maximize your estate for your heirs
If you don’t need to tap your IRA funds during your lifetime, converting to a Roth IRA allows your savings to grow undiminished by RMDs, leaving more for your heirs who can also benefit from tax-free withdrawals within the ten-year period.
You want tax diversification
If all your retirement savings is currently in traditional accounts, shifting some to a Roth account can make it easier to pay for big-ticket expenses without adding to your taxable income. Whether it’s financing a new roof or a multi-generational trip to celebrate a landmark birthday or anniversary, pulling extra money beyond your RMD from a traditional account will increase your taxable income for the year. Pull the money out of a Roth IRA and there’s no tax due.
You want to keep your savings safe from the government
Most people realize that we’re going to have to come up with money from somewhere to pay for the six to eight trillion dollars in coronavirus stimulus payments, and the spending just keeps coming. Our country is in deep debt, and that might very well mean that Washington is coming for your savings. If you want to keep your savings safe, consider converting now.