A Roth conversion is the process of converting a traditional individual retirement account (IRA) or employer-sponsored retirement plan, such as a 401(k), into a Roth IRA. The conversion is treated as a taxable event, meaning that the amount converted is taxed as ordinary income in the year it is converted. The key difference between a traditional IRA and a Roth IRA is the way they are taxed. Contributions to a traditional IRA are made on a pre-tax basis and are taxed as ordinary income when they are withdrawn, while contributions to a Roth IRA are made on an after-tax basis and are not taxed when they are withdrawn.
At Oakwell Private Wealth Management, we believe that every individual’s financial situation is unique, and that’s why we offer customized solutions to help our clients meet their financial goals. One option that many of our clients consider is a Roth conversion. In this blog post, we’ll explain 4 reasons why Roth conversions might be beneficial for you.
1. Tax Free Growth & Tax-Free Distributions in Retirement
One of the biggest benefits of a Roth conversion is the ability to withdraw funds from the Roth account tax-free in retirement. With traditional retirement accounts, like a traditional IRA or 401(k), you will owe taxes on the distributions you take in retirement. With a Roth conversion, you pay taxes on the converted amount upfront, but the account grows tax-free and the future distributions are tax-free. This means you’ll have the benefit of knowing that once the taxes are paid for the tax year of the conversion, no taxes will be assessed going forward on the growth, distributions, or even inheritance of this type of account.
2. No Required Minimum Distributions (RMDs)
Another benefit of a Roth conversion is the absence of Required Minimum Distributions (RMDs). With traditional retirement accounts, you are required to take RMDs starting at age 73. With a Roth IRA, there are no RMDs, so you have the flexibility to decide when and how much you want to withdraw. This is particularly beneficial for those who want to pass on their retirement savings to their heirs.
3. Market Upside Potential
Roth conversion gives you the potential to benefit from market upside. When you convert a traditional 401(k) or IRA to a Roth IRA, you are taxed on the full value of the conversion amount, which includes any market gains or losses. If the market is down, the value of your traditional IRA is lower, meaning that you will have a lower tax bill on the conversion. This can provide a unique opportunity to pay taxes on a lower balance and benefit from tax-free growth in the future.
When you leave your Roth IRA to your beneficiary, they will be able to withdraw the funds tax-free over a ten year period. This can be especially beneficial for beneficiaries who are in a higher tax bracket than you or expect to be in a higher tax bracket in the future.
The decision to convert to a Roth IRA should be based on several factors, including your current and expected tax bracket, your time horizon, and your financial goals. Converting to a Roth IRA can be a good choice if you expect to be in a higher tax bracket in retirement, you are currently in a lower tax bracket with a sizable traditional account, if you want more flexibility in how and when you take distributions, or if you want to leave a tax-free legacy to your heirs.
It's important to note that there are limitations on who can make contributions to a Roth IRA, based on income and filing status. Additionally, there are rules around the conversion amount, such as the availability of funds to pay taxes on the conversion, and the requirement to hold the converted funds in the Roth IRA for a certain period of time.
In conclusion, a Roth conversion is a powerful tool for managing your retirement savings and achieving your financial goals. It offers the potential for tax free growth, tax-free distributions in retirement, the absence of RMDs, the opportunity to benefit from market upside, and a tax free inheritance. If you’re considering a Roth conversion, reach out to Oakwell Private Wealth Management to discuss your options and find out if it’s right for you.
Oakwell Private Wealth Management is a Registered Investment Advisor. Information presented is for educational purposes only and does not intend to make an offer or solicitation for the sale or purchase of any specific securities product, service or investment strategy. Investments involve risk and unless otherwise stated, are not guaranteed. Be sure to first consult with a qualified financial advisor, tax professional or attorney before implementing any strategy or recommendation discussed herein.