By Beau Henderson, Retirement Coach
“I’ve put all my retirement savings into a traditional IRA. But now I’m noticing the benefit of using a Roth IRA instead. Is it worth it to switch?” — Don S.
If you’re a longtime reader, you know that Roth IRAs are one of my favorite savings tools.
Although contributions are taxed, you aren’t subject to tax when you draw from the account later on.
This makes Roth IRAs incredibly helpful in reducing the amount of income tax you’ll pay during your golden years.
But many people like Don have already put their entire savings into a traditional account.
The good news is that there’s a way to rollover traditional IRAs to get all the benefits of a Roth.
You’ll be taxed for doing so. But you’ll be glad you did.
Let me explain.
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The Roth Rollover
If you like the sound of tax-free growth, no required minimum distributions, and lowering your income tax in retirement, it’s worth considering a Roth IRA.
These accounts provide each of these benefits — and more.
But a lot of retirees have already stashed decades of savings into traditional IRAs that don’t offer these perks.
The good news is that it’s possible to convert a traditional IRA into a Roth.
And you can probably even set up your new rollover account with the same financial institution (but you don’t have to).
There are some key things you’ll want to keep in mind.
Since your contributions to the traditional IRA were not taxed, you’ll need to pay taxes on the conversion.
But don’t count on your conversion to cover the costs.
Most Roth accounts follow a “5-year rule” and will penalize you for taking money out unless it’s been over 5 years since your contribution.
So you need to make sure you have enough cash on hand to pay it when tax season rolls around.
Don’t let the sound of taxes turn you away from the idea altogether, though.
Remember… the IRS is going to tax this money sooner or later. It’s just a matter of when.
The IRA sets the rules on how much you’re required to take each year after a certain age.
But when you convert your savings into a Roth, you get to decide when they get to take their share of your savings.
And it pays to get strategic with your decision.
Withdraw From Savings on Your Own Terms
Timing is everything when it comes to rolling over a traditional IRA into a Roth.
If you’re not careful converting, you may end up bumping yourself into a higher tax bracket for the year.
One way to get time on your side is to convert the account gradually — you don’t have to rollover all at once.
By converting in chunks at a time, you control how much of your savings is subject to tax and when.
This can help you cushion the tax burden of the rollover.
You can convert an amount that won’t bump you into a higher income tax bracket for the year. Then you can repeat this year-to-year until your account is fully converted.
Since the IRS has collected their taxes from the account, they’re no longer concerned about how much or when you withdraw.
You’re free to draw from your savings however you choose.
And since these withdrawals aren’t counted as income, less of your Social Security will be subject to tax as well.
You may even be able to rollover a 401(k) or other similar employer-sponsored retirement funds using this same strategy!
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A conversion may not be in everyone’s best interest.
For anyone who can’t afford the tax bill or needs the money within the next 5 years, it may be more hassle than help.
But I strongly believe in the power of a Roth account.
They are the most helpful tool for lowering income taxes in retirement. And they provide you complete control of your savings.