My First Roth Conversion

My First Roth Conversion

Historically I have been focused on pre-tax retirement accounts for the past 20+ years. I’m slowly leaning towards focusing on post-tax retirement accounts because of tax reasons. Most of all my retirement funds are in pre-tax accounts. I’m worried about the tax implications later on so I decided to explore Roth conversions and I just completed my first Roth conversion.

When it comes to retirement accounts, there are two major ones: pre-tax and post-tax. Pre-tax accounts are those accounts like your traditional 401K and IRA where taxes have not been applied and when you withdraw funds, you’ll get taxed at that point. Post-tax accounts are those like Roth 401K or Roth IRA where taxes have already been taken out and when you withdraw from these accounts, you don’t have to pay any taxes including the growth amount. One is not better than the other. They both have pros and cons.

What tax implications am I referring to? Let’s say your 401K amount today is $200,000. When you retire, let’s also say that it doubled to $400,000. Because a traditional 401K money has not been taxed, when you withdraw from your 401K, you’ll be taxed at that time. Instead of $200K of money you would be paying taxes on, now you’re paying taxes on $400K which includes any growth you gained. These pre-tax accounts have a required minimum distribution which means that at a certain age, 70 1/2, you will be required to withdraw your money. This means you can’t keep your pre-tax money in your accounts forever. You will eventually pay the taxes.

Unlike pre-tax retirement money, post-tax retirement accounts won’t incur paying taxes at the time of withdrawal. The money you put in your post-tax account has already been taxed so anything in your account will not be taxed when you withdraw. Let’s say you have $200K in your Roth IRA today. When you retire, let’s also say it went up to $400K. When you withdraw any money, you won’t have to pay taxes including the growth amount.

When you retire, if all you had was pre-tax retirement accounts, you also have to worry about paying taxes on anything you withdraw. That means if you withdraw $100K, you don’t have $100K to spend because some of that portion will have to go towards taxes.

Why did I do a Roth conversion? To avoid paying the taxes later when I don’t have the flexibility. I prefer to pay the taxes now when I’m employed and have income. When you do a Roth conversion, the amount you convert is going to be considered as income and taxes will need to be paid at the tax rate you currently are at. So, let’s say you’re in the 22% tax bracket and you converted $50K. You’ll now owe 22% of $50K in taxes. You might be saying why not wait till retirement, live minimally, and only withdraw a very low amount to get in lower tax brackets later on. I’ve considered that but with the required minimum distribution starting at age 70 1/2, you might be forced into a high tax bracket in retirement and I don’t anticipate working in retirement so paying any taxes is going to come out of my own pocket. I also anticipate my pre-retirement portfolio to grow and that growth is an additional amount to tax.

Here are a couple of things to look out for when considering Roth conversions

  • Understand the tax implications. Conversions will be considered as income. Will this extra income move you to a higher tax bracket?
  • I converted stocks that I had when they dipped and went down in stock price. I can convert more shares when they’re lower than if I would convert them at a higher price.
  • Make decisions that’s right for you, not for everyone else. Roth conversions may not benefit you.

As always, consider working with a financial advisor when it comes to these important decisions. Roth conversions is a tool to use but it’s effective when used properly. Roth conversions may not be right for everyone. My main factor was thinking about the tax implications later on when I no longer have a steady pay check. If you are interested in following my journey, email subscribe to get alerts of latest posts or follow me on FacebookInstagram, and Pinterest.

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