Roth Conversion: Lost job due to Covid, Should I convert my 401k in to a Roth IRA?

 In Ozarks Live

A Roth IRA was created in the Taxpayer Relief Act of 1997.  It is named after the sponsoring senator from Delaware, William Roth.  A Roth Conversion is a planning technique to pre-pay tax on your retirement savings.  You can move a portion or all of your 401k or Traditional IRA funds into a Roth IRA and pay the tax when your return is due in April.

There are several reasons this may be a good idea for your situation.

1. If the amount does not push you into the next tax bracket.

  • You can move it all in one tax year or spread it out over many years.

2. We can estimate what your tax rate will be now, but we don’t have any idea what it will be in the future.

3. Historically today’s income-tax rates are relatively low.  Using this tool you will get rid of paying taxes on this income, for life.

  • Example 1:  If a $500,000 portfolio in a Roth IRA grows to $1 million in 15 years, all of those dollars are yours.

4. You will also get to enjoy the benefits of no mandatory withdrawals unlike the Traditional IRA.

 

If you expect your income to decline in retirement with the current tax rates a Roth Conversion may not be ideal.  Your future tax may be lower than your current tax bracket.

Ideally, you will want to pay the tax due from an after tax account, not from your IRA.  Paying it from your IRA would count as a withdrawal which would be subject to the IRS early withdrawal penalty of 10%, if you are under age 59 1/2.

Roth Conversion Benefits:

At age 59 1/2 you can have access to tax free withdrawals of earnings if the Roth has been established for at least 5 years.

Pay tax on your money now (at tax time)  Consult with your tax planner on tax bracket

Example 2: Convert a $200,000 Traditional IRA into a Roth IRA.  Taxable income is $120,000 a year which puts them in the 24% tax bracket.

  • A complete rollover would add $200,000 to the clients taxable income, which would push them into the 32% tax bracket. The added tax may be over $60,000.
  • Converting only $25,000 would keep them in the 24% tax bracket. The added tax would only be $6,000.

A series of partial conversions may make it easier to pay the taxes from a taxable account.

Other considerations:

  • A conversion may result in the loss of certain tax deductions or credits and higher taxes on Social Security benefits and higher Medicare premiums.

For more guidance if this tool would be a good fit for your situation contact us here.  We would also advise you speak to your tax preparer or planner about the tax ramifications of using this tool in your retirement plan because it is irreversible.

Bruce Porter has been an advisor for over 30 years.  He gives advice and tips weekly on KOLR 10’s Ozarks Live show.  Don’t miss out on our next show, subscribe to our YouTube Channel.


Sources:

https://finance.zacks.com/10-percent-penalty-apply-ira-conversion-6605.html

 

We are an independent firm helping individuals create retirement strategies using a variety of insurance and investment products to custom suit their needs and objectives.  This material is intended to provide general information to help you understand basic financial planning strategies and should not be construed as financial advice.  All investments are subject to risk including the potential loss of principal.  No investment strategy can guarantee a profit or protect against loss in periods of declining values.  

The information contained in this material is believed to be reliable, but accuracy and completeness cannot be guaranteed; it is not intended to be used as the sole basis for financial decisions.  

We are not permitted to offer, and no statement contained herein shall constitute, tax or legal advice.  Individuals are encouraged to consult with a qualified professional before making any decisions about their personal situation.  Our firm is not affiliated with the U. S. government or any governmental agency.  Investment advisory services offered only by duly registered individuals through AE Wealth Management, LLC (AEWM).  AEWM and The Resource Center are not affiliated companies. 659601

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