Unlock the financial secrets of the experts with by using this smart move with your 401(k)
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As the golden years roll in, so do the complexities of managing retirement funds. It's a time when every penny counts, and the tax implications of your decisions can have a lasting impact on your financial comfort.
While traditional wisdom has guided many to stick with their traditional IRAs or 401(k) plans, a strategic maneuver known as a Roth conversion could be the ace up your sleeve, potentially saving you thousands in taxes during your retirement.
Let's take a page from the playbook of Brent Ehmke, a 72-year-old retired aerospace executive from Plano, Texas.
As reported by The Wall Street Journal (WSJ) Ehmke faced a daunting realization: his required minimum distributions (RMDs) from his tax-deferred retirement account would soon exceed $100,000 annually. Combined with his other income streams, he was staring down the barrel of a significant tax bill.
Ehmke's predicament is not uncommon among retirees. The questions he—and perhaps you—might be asking is, “Did I make a mistake? Did I wait too long?” The answer lies in understanding the benefits of a Roth conversion.
A Roth IRA is a retirement account that is funded with after-tax dollars, allowing for tax-free withdrawals later on. In contrast, traditional IRAs and 401(k)s are funded with pre-tax dollars, with taxes paid upon distribution.
The Roth conversion process involves transferring some or all of your funds from a traditional IRA or 401(k) to a Roth IRA, triggering a tax event based on the amount converted and your current income tax bracket.
The beauty of a Roth IRA lies in its flexibility. Unlike traditional retirement accounts, Roth IRAs have no RMDs during the owner's lifetime.
This means you can let your investments grow tax-free for as long as you live, providing a valuable tool for managing your taxable income.
For retirees with sufficient income, a Roth conversion can be a savvy financial move. Once you reach age 72—or 73 if you reach age 72 after December 31, 2022—you're required to take RMDs from your tax-deferred accounts.
These mandatory withdrawals can bump you into a higher tax bracket, increase your Medicare premiums, and even trigger the 3.8% net investment-income surtax.
By converting to a Roth IRA, you can avoid these pitfalls. You'll pay taxes upfront during the conversion, but this can prevent you from being pushed into a higher tax bracket in the future.
According to the WSJ, “Avoiding RMDs and keeping your income lower this way can also help prevent your Medicare premium rising or the 3.8% net investment-income surtax being triggered.”
To avoid finding yourself in a higher tax bracket for the year or seeing a rise in your Medicare premium, the WSJ recommends to make small conversions over time. They add, “In general, Roth IRA conversions make sense if the saver’s tax rate on the converted amount is lower than what the tax rate would be on future withdrawals.”
Roth conversions also allow one to leave money to your kids or heirs after passing away.
Although, the decision to convert to a Roth IRA should not be taken lightly. It requires a careful analysis of your current financial situation, future income projections, and tax implications.
It’s important to plan how to pay for long-term care since those costs are tax-deductible. This approach also fits higher-income earners who don’t need all of their RMDs or have lower retirement expenses.
Remembering the five-year period guideline is also a must if you plan to acquire distributions from the Roth IRAs. Earnings are only tax-free if at least five years have passed since your first contribution. So, it’s not recommended for someone who needs money within a short period of time.
Whatever you decide upon, remember that a Roth conversion cannot be undone.
Have you considered a Roth conversion? What factors influenced your decision? Share your experiences and insights in the comments below!
While traditional wisdom has guided many to stick with their traditional IRAs or 401(k) plans, a strategic maneuver known as a Roth conversion could be the ace up your sleeve, potentially saving you thousands in taxes during your retirement.
Let's take a page from the playbook of Brent Ehmke, a 72-year-old retired aerospace executive from Plano, Texas.
As reported by The Wall Street Journal (WSJ) Ehmke faced a daunting realization: his required minimum distributions (RMDs) from his tax-deferred retirement account would soon exceed $100,000 annually. Combined with his other income streams, he was staring down the barrel of a significant tax bill.
Ehmke's predicament is not uncommon among retirees. The questions he—and perhaps you—might be asking is, “Did I make a mistake? Did I wait too long?” The answer lies in understanding the benefits of a Roth conversion.
Roth conversions involve moving funds from a traditional IRA or 401(k) to a Roth IRA, which could save taxes during retirement years. Image source: Pexels / Towfiqu barbhuiya.
A Roth IRA is a retirement account that is funded with after-tax dollars, allowing for tax-free withdrawals later on. In contrast, traditional IRAs and 401(k)s are funded with pre-tax dollars, with taxes paid upon distribution.
The Roth conversion process involves transferring some or all of your funds from a traditional IRA or 401(k) to a Roth IRA, triggering a tax event based on the amount converted and your current income tax bracket.
The beauty of a Roth IRA lies in its flexibility. Unlike traditional retirement accounts, Roth IRAs have no RMDs during the owner's lifetime.
This means you can let your investments grow tax-free for as long as you live, providing a valuable tool for managing your taxable income.
For retirees with sufficient income, a Roth conversion can be a savvy financial move. Once you reach age 72—or 73 if you reach age 72 after December 31, 2022—you're required to take RMDs from your tax-deferred accounts.
These mandatory withdrawals can bump you into a higher tax bracket, increase your Medicare premiums, and even trigger the 3.8% net investment-income surtax.
By converting to a Roth IRA, you can avoid these pitfalls. You'll pay taxes upfront during the conversion, but this can prevent you from being pushed into a higher tax bracket in the future.
According to the WSJ, “Avoiding RMDs and keeping your income lower this way can also help prevent your Medicare premium rising or the 3.8% net investment-income surtax being triggered.”
To avoid finding yourself in a higher tax bracket for the year or seeing a rise in your Medicare premium, the WSJ recommends to make small conversions over time. They add, “In general, Roth IRA conversions make sense if the saver’s tax rate on the converted amount is lower than what the tax rate would be on future withdrawals.”
Roth conversions also allow one to leave money to your kids or heirs after passing away.
Although, the decision to convert to a Roth IRA should not be taken lightly. It requires a careful analysis of your current financial situation, future income projections, and tax implications.
It’s important to plan how to pay for long-term care since those costs are tax-deductible. This approach also fits higher-income earners who don’t need all of their RMDs or have lower retirement expenses.
Remembering the five-year period guideline is also a must if you plan to acquire distributions from the Roth IRAs. Earnings are only tax-free if at least five years have passed since your first contribution. So, it’s not recommended for someone who needs money within a short period of time.
Whatever you decide upon, remember that a Roth conversion cannot be undone.
Have you considered a Roth conversion? What factors influenced your decision? Share your experiences and insights in the comments below!
