Should I convert my 401(k) or IRA to a Roth IRA?

Converting a 401(k) or IRA to a Roth IRA can be a strategic financial move for individuals that want to create more flexibility around their investment portfolios. While there can be many potential benefits, the decision should be made based on individual circumstances, and should be analyzed within the context of an overall financial plan. Here are some of the potential advantages to consider:

Tax Diversification - One of the benefits of converting a 401(k)/IRA to a Roth IRA is tax diversification. Unlike traditional retirement accounts, Roth IRAs are funded with after-tax dollars not pre-tax dollars. By converting, you create a tax-diversified retirement portfolio, allowing you to manage your tax liability during retirement. This can be valuable in a rising tax rate environment when IRA distributions could be taxed at a higher rate in the future.

Tax-Free Withdrawals - Roth IRAs offer tax-free withdrawals on both contributions and earnings after age 59 ?, provided the account has been open for at least five years. This can be advantageous in retirement, as it allows for more flexibility in managing your income streams and the tax liability associated with them while also potentially reducing your overall tax burden throughout retirement.

No Required Minimum Distributions (RMDs) - Unlike traditional retirement accounts, Roth IRAs do not require Required Minimum Distributions (RMDs) at age 73. This can be advantageous for those who want to maintain control over their retirement income and avoid forced withdrawals that may push them into higher tax brackets especially if these funds are not needed for retirement income.

Estate Planning Benefits - Roth IRAs can provide significant estate planning advantages. Since there are no RMDs during the original account holder’s lifetime, the account can continue growing tax-free, providing a tax-efficient inheritance for beneficiaries. According to current law, once inherited, the Roth IRA can grow tax-free for an additional 10 years before withdrawals are required. This can be particularly beneficial for passing on more wealth to the next generation.

Reduced Taxable Income in Retirement - Converting 401(k)/IRAs to a Roth IRA can be a strategic move for individuals expecting to be in a higher tax bracket throughout retirement. Paying taxes on the conversion now, when income and taxes may be lower, can result in reduced taxable income during retirement, potentially lowering overall tax liability. Converting in retirement before drawing social security can make this strategy potentially very attractive. Remember, RMD’s could increase retirement income in the future.

Financial Flexibility - Roth IRAs offer more flexibility in terms of early withdrawals. While it’s generally advisable to leave retirement savings untouched, especially accounts that are growing tax-free, Roth IRAs allow withdrawals of contributions (not earnings) before and after age 59 ?, providing a source of emergency funds if needed without paying taxes or penalties.

No Age Limit for Contributions - Roth IRAs and Traditional IRAs have no age limit for contributions. This means you can continue contributing as long as you have earned income, allowing for potential additional growth.

Hedging Against Tax Changes - Given the unpredictability of future tax policies, converting to a Roth IRA can be a way to hedge against potential tax increases. Paying taxes upfront at current rates can be a strategic move if you anticipate higher taxes in the future. Ask yourself this question If you believe taxes will be higher in the future; “Does it make sense to defer taxes today at a low rate only to have to pay in the future at a higher rate”?

Access to a Wide Range of Investments – Both Traditional IRAs and Roth IRAs can offer a broader range of investment options compared to many employer-sponsored 401(k) plans. This increased flexibility can allow you to tailor your investment strategy to suit your financial goals and risk tolerance.

It’s essential to note that while there are numerous potential benefits to converting a 401(k) or Traditional IRA to a Roth IRA, individual circumstances vary. Factors such as current and future tax implications, retirement goals, and financial needs should be carefully considered. Talk to us today to get personalized guidance based on your specific situation.