Can a ROTH conversion work for you? We’ll explain more, this week on Elevate Wealth.

FULL TRANSCRIPT:

Hey, everybody! I get asked a lot about Roth conversions, particularly from newly retired clients or those who are considering retirement in the next few years. So today, I thought I would explain Roth conversions and who might want to do them. In order to understand a Roth conversion, you have to first understand the differences between traditional IRAs and Roth IRAs. So to do this, we use a graphic that we affectionately call our "tax buckets." With traditional IRAs on this side of the page, funds go into this bucket pre-tax, so dollars that sit in this bucket have never been taxed before, and we'll link this graphic into the video so that you can download it yourself. The funds inside of here are allowed to grow without any taxes until the funds are taken out, generally when you're retired and you're ready to spend them, and that's when the taxes start. And it sounds silly, but we say that the dollars inside a traditional IRA are infested with taxes, and that's because every dollar that comes out of this bucket is taxed at ordinary income tax rates, and there's really no way to get around it. If you take the funds out, you pay taxes. If you leave this account to someone else, they pay taxes. And the funds inside will continue to grow and compound if you have it invested, and then you'll pay taxes on those dollars someday too. Also someday, you'll have a Required Minimum Distribution and be forced to take the funds out over time and pay those taxes. Like I said, infested with taxes. The Roth IRA, on the other hand, is exactly opposite. Contributions that go into the Roth IRA go in after tax, so you've already paid the tax on that money before you make the contribution. It's just like going to the grocery store and buying groceries...you've already paid tax on those dollars in the form of withholding from your paycheck, so you buy your groceries with after-tax money. Once inside the Roth bucket, the funds are allowed to grow without taxes going forward, and here's the best part: when you take the funds out to spend in retirement, provided that you're over age 59 and a half and held the account for at least 5 years, then the funds are completely and utterly free of income taxes, even the dollars that grew inside the account are free of income taxes. So why don't we put all of our money into Roth IRAs? Well, there's a couple of main reasons. Traditional IRAs give us a tax break now, so many people would prefer to defer the tax until later, and that would make sense if they're in a higher tax bracket now then they think they will be later. Also there's an income cap on Roth IRA contributions, so if you're a high income earner, you might not be eligible to put money into a Roth IRA. So let's say you've been putting funds away into the traditional IRA but now you've seen the advantages of what tax-free withdrawals later could mean for your income stream. So you want to move some funds from your traditional IRA to a Roth IRA. This is called a conversion, traditional to Roth IRA, and it's completely legal. It's also completely taxable. The IRS allows us to convert as much as we want from our traditional IRA over to our Roth IRA, and we can do it all, or we can just convert some of it, and there's no cap or limit or income restrictions. But the IRS also loves it when we do this because every dollar we convert is taxable, so so the magic happens when we do some planning and we're strategic about when we choose to do conversions. You probably don't want to do a conversion if you are a high income earner or when you're toward the end of your career and you're in your highest paying years. At that point you might want to wait until you retire or you have a lower income year. It's all about projecting your tax rate now versus later. Will you be in a lower tax bracket later? If so, then you want to wait to do conversions. But if you think you'll be in a higher tax situation later, then maybe take advantage of your current tax bracket while it's lower and do some conversions. Every family and every individual's situation is different, but in general at Elevate, we really love it when we can help our clients save across the tax buckets in order to build a tax-efficient retirement income stream, and planning for Roth conversions is just part of that strategy. At Elevate Wealth Advisory, we're here to create a customized plan to help you save money for retirement. If your adviser is doing this for you, we can help. Visit elevate-wealth.com, and click "Let's Talk."