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A Road to Roths

Imagine! Your children are grown. Your career is behind you. You are spending your time with your grandchildren, serving your church or local charities, donating and being generous with the money you have, and intending to leave a financial legacy for your next of kin. You are enjoying this retirement reality with a little help from your Roth IRA, which has tax-free distributions and no required minimum distributions (RMDs). You can avoid worrying about increasing tax rates and exhausting your money too early.

However, what could be lying between you and this future life is your income right now. If your modified adjusted gross income for 2022 is $214,000 or more (married filing jointly), you may not be eligible for a Roth IRA at all. You would have to stick with mostly pre-tax options that have RMDs rather than the after-tax, RMD-free Roths.

Or maybe, what is lying between you and this future life is most of your money is already inside of a pre-tax account like a traditional IRA. Maybe, you were not introduced to Roth IRAs until later in your career, or Roth IRAs, created in 1997, simply did not exist for sizable portion of your working years. Even if you have started contributing to a Roth and are within the income limits, you still have this pool of money inside a future-RMDing, pre-tax account.

Your solution could be a Roth conversion, a strategy where funds inside a traditional IRA can be transferred to a Roth IRA. It is a circumvention of income limits, and it is an option to those who want to convert their current retirement assets to exclusively Roth IRAs.

Beware: A taxable event might apply. If you are converting a pre-tax pool of money from a traditional IRA into a Roth, then likely, depending on your exact situation, 100% of the converted funds are included in your income and, thus, subject to taxes. If you are simply trying to circumvent the Roth income limits and have no other assets in your traditional IRA other than current year contributions, you may be able to "backdoor" the funds into a Roth without the conversion causing your taxable income to rise at all. If your situation is somewhere in-between those two scenarios, your taxable income could rise by a portion of the converted amount. 

Since the conversion could be taxable, it may very well make sense to do the conversion this year. Maybe, your earned income is lower this year than you expect it will be in future years. Not to mention, the market is down year-to-date, so a conversion might not raise your taxable income as much as it otherwise could if the market is up. Keep in mind, nobody knows what the market could do in the future.

It is also important to note that there are always risks with any investing strategy. Laws and regulations, including tax laws, regarding different investment accounts can change across time. There is no guarantee that Roth IRAs never include RMDs or that the distributions remain tax free.

Schedule an Annual Review with a Coach at SmartPlan Investing to discover what strategy may best help you reach your short term and long-term goals. This article is not comprehensive and should not be used to make any investment or tax decisions.

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Saturday, 10 December 2022

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