Pondering over the decision to move your tax-sheltered retirement funds to a Roth account? Consider these factors.
Living comfortably and financially free in your golden years is a dream many of us share. A key strategy to achieving this is keeping some of your retirement savings in a tax-exempt account.
CPAs and certified financial planners recommend shifting at least some of your tax-deferred savings from your 401(k) or traditional Individual Retirement Account (IRA) into a Roth account. Money funneled into Roth 401(k)s and Roth IRAs grows tax-free and can be withdrawn tax-free, provided the account has been owned for at least five years since the first rollover.
Unlike creating a Roth IRA with annual contributions and income limits, converting savings is accessible to everyone, regardless of income level.
Another benefit? You decide when and how much to make withdrawals from your Roth savings, unlike with tax-deferred savings in traditional IRAs and 401(k)s, which require mandatory withdrawals starting at age 73.
However, Roth conversions may not be ideal for everyone. Here's what to assess before making a move:
The Basics
Most 401(k) plans (93%) allow participants to open a Roth 401(k) account within the plan, with 60% permitting in-plan conversions. These allow you to convert some or all of your tax-deferred savings to tax-free Roth savings.
The downside? You'll have to pay the taxes due on the amount converted in the year of conversion. Therefore, deciding the optimal amount to convert at a time comes down to if you can afford the immediate tax bill.
Questions to Consider
Consulting a CPA or a financial planner with tax expertise is essential when weighing Roth options. Here are some crucial factors to ponder:
- Growth of Income: If you're in the early stages of your career, your income is likely to rise. It might be more advantageous to convert sooner to minimize taxes and enable your tax-free savings to grow longer.
- Affordability: Ideally, you should have enough cash on hand to pay the one-time tax bill without affecting your current financial needs or future savings.
- Future Taxes: If you anticipate your retirement income taxes will be higher than now, converting tax-deferred savings into a Roth is favorable. Converting sooner will maximize the value gained.
- Optimal Conversion Time: Perform conversions during market downturns to attain the most tax benefit. Investing in assets through a Roth during lows allows for tax-free growth when recovery occurs.
- Retirement Income Sources: Consider the type and amount of income you'll receive in retirement to estimate your tax obligations. Combining taxable and tax-free savings can help optimize withdrawal strategies.
- Inheritance: Roth accounts are advantageous when passing wealth to non-spousal heirs as they offer tax-free withdrawals and more growth opportunities within the 10-year inheritance period.
Ensuring financial stability in retirement requires careful planning and ongoing decisions. A tax-free Roth account can be a valuable tool in providing the freedom to live life on your terms.
- In the strategy for financial independence during retirement, especially for those with a longer career ahead, it might be beneficial to consider converting some tax-deferred savings into a tax-free Roth account, because the growth of income in the future could warrant a lower tax bill in comparison.
- When contemplating a Roth conversion, managing the immediate tax bill is crucial, as converting a portion of your tax-deferred savings will result in a one-time tax payment in the year of conversion.
- Regarding the advantages of a Roth account, it offers added flexibility, as you can decide when and how much to make withdrawals, unlike with tax-deferred savings in traditional IRAs and 401(k)s, which subject retirees to mandatory withdrawals starting at age 73.
