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Save Taxes Over Time – Two Roth Conversion Strategies

Save Taxes Over Time – Two Roth Conversion Strategies

There are many things to consider when looking at Roth conversion strategies. Each person’s current and future situation should be reviewed to determine the best plan of action. Congress, in an effort to increase present-day tax revenue, has made Roth IRA conversions available to a greater number of individuals by removing income limits and increasing eligibility. Here are a couple strategies you may want to consider.

Strategy One

IRA to Roth IRA converting is a wonderful planning tool for individuals with large traditional IRA accounts who expect their future tax bills to stay the same or rise at the time they plan to start taking withdrawals from their tax-deferred accounts.

If you’re not eligible to contribute to a Roth IRA and your employer’s 401(k) plan does not allow you to make Roth-designated deferrals, another way to take advantage of a Roth IRA's potential benefits is to convert some or all of your traditional IRA money to a Roth.

Things to consider before IRA to Roth IRA conversion:

  • You will pay current income tax on the amount you convert to a Roth IRA.
  • Converting may push you into a higher tax bracket and additional taxes and penalties may apply if you have other tax deferred assets.
  • Know the tax consequences prior to conversion and have funds set aside.

Strategy Two

Backdoor Roth IRA strategy is another great planning tool due to income limitations where not all investors can open a Roth IRA.  If you think tax-free income in retirement will be important to you but you’re ineligible due to income levels, you might want to consider the backdoor Roth. In a backdoor Roth, you initially make a nondeductible contribution to a traditional IRA. This is followed by an immediate conversion to a Roth IRA.  It is legal, but a little more complicated.  The main advantage of the backdoor Roth IRA is that while you do not deduct the initial contribution from your taxes, all future Roth IRA distributions in retirement will be tax free.

Things to consider before IRA to backdoor Roth IRA conversion:

  • Roth IRA income limits do not apply to a backdoor Roth IRA conversion.
  • Normally there is an IRA contribution limit of $5,500 ($6,500 if you are over age 50) to an IRA.
  • A backdoor Roth is not a way to escape taxes. You will need to understand the pro-rata rule and how it applies to your situation.
  • Backdoor Roth IRA conversions work best when you have no other IRA accounts. This way if you made the non-deductible IRA contribution, you are free of paying any taxes on the conversion.

Ideal conversion candidates for both strategies are:

  • If you have wealth and do not need to use the money in retirement. You may be seeking to leave an income-tax-free Roth IRA for heirs or to reduce estate settlement costs.
  • If you are looking at an extended time horizon and your income tax bracket will be the same or higher when you retire than it is today.
  • If you are younger high income earners.   

Work with a professional

Though the principles of managing an IRA are simple and you may be tempted to do it yourself, the process can be complicated and the penalties severe. Before considering a Roth IRA conversion or backdoor Roth, contact your financial advisor for guidance.  

Article published in Milwaukee Business Journal 2017 Guide to Wealth Management, May 2017

All information herein has been prepared solely for informational purposes only and opinions are subject to change. Past performance is not indicative of future results and all investments involve the risk of loss of principle. For information on how these general principles apply to your situation, consult an investment professional.

Article Topic Specialist: Maureen Hansen

Maureen is the President of SVA Wealth Management, LLC. Working closely with clients, Maureen focuses on building long-term relationships based on trust and understanding.

With over two decades of investment experience, Maureen specializes in three primary areas of practice including asset management, divorce consulting and retirement planning.

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