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Taxes are a valid concern if you want to roll over $720,000 from your retirement fund into a Roth IRA. While you won’t pay any taxes if the assets you’re rolling over are held in another Roth account, there’s typically no way to completely avoid paying taxes when rolling pre-tax money into a Roth IRA. However, with a few strategic moves, you can potentially limit today’s tax pain while still reaping the rewards of tomorrow’s tax-free benefits. To determine if a Roth rollover aligns with your overall savings and tax strategy, consider running the numbers with a financial advisor who’s attuned to your financial situation and retirement vision.
A Roth IRA is a retirement account that allows people to contribute after-tax dollars. Unlike a traditional IRA, you don’t get a tax break on Roth contributions. However, qualified Roth withdrawals in retirement can be made tax-free. This differs from traditional IRAs, whose contributions are often tax-deductible but withdrawals are taxed as ordinary income.
In general, you can roll over funds from another retirement account such as a traditional IRA or 401(k) into a Roth IRA. This is called a Roth conversion or Roth rollover. When you convert funds, you owe income taxes on the amount that’s rolled over for that year. So if you roll over $50,000 from a traditional IRA to a Roth IRA, the $50,000 is added to your taxable income for the year.
It’s important to understand that Roth rollovers are not the same as Roth contributions. Higher-income taxpayers may not qualify to make direct Roth contributions. However, there are no income limits on doing Roth conversions from other accounts.
You can roll over funds from 401(k)s, 403(b)s, 457 plans, traditional IRAs, SEP IRAs and Simple IRAs. To start the process, contact the institution that holds the account you want to roll over and convert. They can help facilitate the transfer. You typically have 60 days to complete the conversion, otherwise, the IRS will treat the transfer as a distribution and you could be hit with a 10% early withdrawal penalty. But if you need additional help determining how much to roll over and convert, consider speaking with a financial advisor.
There are a few key reasons why an individual might choose to do a Roth conversion:
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Tax-free growth: Money that’s converted into a Roth IRA grows tax-free. This differs from traditional IRAs whose investment earnings are tax-deferred but eventually get taxed when they’re withdrawn. Roth withdrawals will be 100% tax-free, provided you satisfy the five-year rule and are 59.5 years old.
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Avoid RMDs: Traditional IRAs are subject to required minimum distributions (RMDs) – mandatory withdrawals that start at age 73. For those who don’t need these distributions, RMDs can create excess taxable income. However, Roth conversions eliminate future RMDs since Roth accounts are not subject to these rules.
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Tax savings: Paying conversion taxes now can make sense if you expect to be in a higher tax bracket in retirement. Roth conversions lock in today’s rates. They also reduce future RMD amounts that could push you into a higher bracket.
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Inheritance planning: Heirs who inherit Roth IRAs can potentially stretch out tax-free distributions over their life expectancy, depending on their relation to the person who died. However, some beneficiaries will be required to empty the account within 10 years.
