The switch will leave you with a potentially hefty tax bill, but you can make tax-free withdrawals from the Roth account in the future. Since you weren’t taxed on any money in your traditional IRA, you owe taxes when you switch to a Roth. But if the value of your portfolio has just fallen, it’s cheaper than usual to transfer your shares. Roth IRAs allow investors to deposit after-tax dollars in return for tax-free distributions in retirement.
Tax parity is another benefit of Roth IRAs, as you have different income ranges that you can draw from in order to keep your taxes low in retirement. When you convert a traditional IRA to a Roth IRA, you owe tax on any money in the traditional IRA that would have been taxed when paid out. But what if you have a different retirement plan? The good news is that you can convert plans like a 401 (k) or a traditional IRA to a Roth IRA and take advantage of their benefits. Now may be a good time to do so. That way, they may be able to avoid moving into a higher tax bracket and paying more for every extra dollar of money converted.
Unlike a traditional IRA, you don’t have to pay income tax on the money you withdraw, nor do you have to withdraw a minimum amount from your account every year after you reach a certain age. Currently, there are essentially no limits on the number and size of Roth conversions you can make with a traditional IRA. You can invest in a Roth IRA at any age, as long as you have enough earned income to cover the contribution. With a traditional IRA or 401 (k), you have a set minimum that you must withdraw each year once you reach RMD age. However, Roth IRAs do not comply with this rule.
The advantage of this is that if the market fell, your IRA value is likely to have also fallen — so your full value has fallen and you pay tax on the current value (which is lower since the market is down than months ago). You must follow the IRS’ prorated rule, which requires you to calculate the tax consequences taking into account all of your IRA assets. Imagine you’re worried about the economy and want to reallocate your Individual Retirement Account (IRA) funds from stocks to bonds and into cash. So if you’re lucky enough not to have to withdraw money from your Roth IRA, you can simply let it continue to grow and let your heirs withdraw tax-free one day.
If you need help, you can use Personal Capital and its free Roth IRA conversion calculator to estimate how much tax you owe by converting some or all of your accounts into an IRA. 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. The downside of a Roth IRA conversion is that the amount of your IRA money that is transferred to a Roth IRA becomes taxable in the year of the conversion.
