Roth conversion is when you convert your pre-tax retirement funds to after-tax retirement funds. It’s a tool to use in your retirement or early retirement calculations. Moving funds from a pre-tax retirement account to an after-tax retirement account which allows it to grow tax free and when you withdraw from an after-tax retirement account you won’t have to pay taxes because you’ve already paid taxes on it. That’s the beauty of a Roth retirement account. However, you need to be careful and strategic when doing this as I’ve learned this past year. Beware of this with Roth conversions. 

Performing a Roth conversion is very simple with my broker. I log into my account and I move money and/or securities from my IRA to my Roth IRA. It automatically knows that it is a Roth conversion and it will display a warning message to recognize any tax implications. This may sound very simple but the details are very important. When you move money from a pre-tax retirement account to an after-tax retirement account you will have to pay taxes.  

For tax filing purposes, you will receive a 1099-R form showing how much you converted and how much of that is taxable. In my case, taxes will be assessed on the entire amount I converted. For example, if you converted $25,000 you will have to pay taxes on $25,000. The amount of taxes will depend on your income bracket because Roth conversions will be treated as income.  

Be aware! These Roth conversions will add to your income. If you elected not to with withhold taxes at the time of the conversion, you will be responsible for paying taxes during your tax filing. The more you convert the more taxes you will have to pay. I’ve been doing conversions for the past 4 years and last year was the most I converted in a year.  

I started preparing my tax filing, entered all my numbers, and BAM! I owe a lot more than I planned for. When I look back I executed four Roth conversions last year. Why did I convert so many times and so much? When the market goes down and stock prices drop, it’s an opportunity to convert at a lower price hoping your conversions will go up after you convert. After you convert, you won’t have to pay taxes on the growth or the dividends you receive now that it is in a Roth account.  

Why do Roth conversions now especially when I have to pay taxes on them and have a bigger liability to the government? My reasoning is pay the taxes now while I have a job and income and in return, my Roth account will grow tax free.  

Let’s say you converted $50,000. If that $50,000 grew to $100,000 when you retire, you won’t have to pay any taxes on the growth. That $100,000 is all yours. If that same $50,000 grew to $100,000 in your IRA, you will have to pay taxes on the entire $100,000.  

Pros 

• Builds up your after-tax account 
• Converted investments will grow tax free including the growth and any dividends 

Cons 

• Have to pay the taxes now 
• If you don’t plan well you could be left with a big tax liability 

To help lessen the burden on the tax liability and you are going to do Roth conversions, withhold extra taxes from your paycheck throughout the year. This, of course, will mean you will have a smaller paycheck but if you can swing this it will help with the taxes.  

Roth conversion is an effective tool to build after-tax wealth. It grows tax free so when you withdraw at the minimum age you won’t have to pay the government anything. Pay taxes now or pay taxes later. Just be cautious not to over convert and beware of this with Roth conversions. If you are interested in following my journey and their journey, follow them on Instagram and email subscribe to get alerts of latest posts or follow me on Facebook, Instagram, and Pinterest.