The availability of funds to pay income taxes. To help you manage your tax liability, you can choose to convert only a portion of your assets. There is no limit to the number of conversions you can make, so you can convert smaller amounts over several years. When it’s time to file taxes for the year you made the switch, you’ll need to file Form 8606 to notify the IRS that you’ve converted an account to a Roth IRA.
Any money that is transferred from a traditional account to a Roth is treated as normal income and taxed accordingly. That can add up a huge tax bill, so you need to have the money ready to pay it. Alternatively, you can upgrade the account over a period of several years to limit the tax burden in a single year. If the value of your retirement account has dropped, this could be a good time to switch to a Roth IRA, as the tax impact is lower than if your account is worth more.
It is generally advisable to carry out the conversion over several years and, if possible, convert more into years when your income is lower. Traditional IRAs are financed with pre-tax money, which means you can deduct any contributions you make in a given year from your taxable income. And if you’re converting a particularly large account, you should consider how you can minimize your tax expenses so that working with a tax advisor can pay for itself and more. When you convert a traditional IRA to a Roth IRA, you pay taxes on the converted money to secure tax-free withdrawals in the future, as well as various other benefits, including no required minimum distributions.
While a Roth IRA conversion can be relatively easy to set up, there are a few rules you should follow so that you maximize your opportunities and avoid paying unnecessary taxes. With a Roth IRA, you can save for retirement on a tax-deferred basis, which gives you some attractive incentives to prepare for your golden years. If you’re getting Obamacare or filling out a FAFSA application, it’s important to consider this when deciding how much, if any, you want to convert. However, people in this situation can still convert traditional IRAs into Roth IRAs, the strategy known as the backdoor Roth IRA.
Individuals first contribute to a non-deductible IRA and then convert it to a Roth IRA — the so-called backdoor Roth IRA approach. Traditional IRAs force you to claim the required minimum distributions (RMDs) every year after you reach the age of 73*, regardless of whether you actually need the money. Once your shares are converted, they will ideally continue to grow tax-free in your Roth account until you’re ready to withdraw the money in retirement. You must follow the IRS’ prorated rule, which requires you to calculate the tax consequences taking into account all of your IRA assets.
To understand the benefits of a Roth conversion, it’s important to know the key differences between traditional and Roth IRAs.
