Retirement is coming.
I don’t mean to sound like a Game of Thrones character, but it’s the truth.
In order to be retired and living our best lives by 65, we have to be planning and saving now. And retirement planning is more than just saving the money. You have different options to maximize the effectiveness of your retirement accounts and really make your money work for you.
One way that people work the system a little bit is by doing a Roth IRA conversion. A Roth IRA conversion is when people who have been investing in other retirement accounts (see the full list here) convert those accounts to Roth accounts. It’s a pretty common practice and one that can be a great help for certain retirees.
Why Would You Do a Roth IRA Conversion?
The main reason people do Roth conversions is for tax benefits. With Roth IRA accounts, you pay taxes up front when you invest your money. Then your withdrawals in retirement are tax free. When you convert your other retirement accounts, whether the money went in pre- or post-tax, you can withdraw it tax free after the conversion is done.
Roth IRAs also don’t have required minimum distributions (RMDs). With Traditional IRAs, you need to start taking RMDs when you reach 70½ years old. People who want to leave their money in the market like to make the switch to a Roth to let it grow as much as possible. This can be very helpful for people who got a late start on retirement saving or who want to grow their money so that they can leave more to their heirs.
Along that line, here’s what happens if you pass your Roth IRA account on to your heirs. They do have to take required minimum distributions, but they don’t have to pay taxes on their withdrawals if the account has been open for at least five years. Someone who inherits a traditional IRA has to pay taxes on their withdrawals.
A Step-by-step Guide to Converting to a Roth IRA
Here’s how you can convert your other IRA accounts into Roth accounts if you want to. For all these options, you must have already opened your Roth IRA account.
60 Day Rollover
This may be the most common conversion out there.
- Determine how much money you want to convert. You have the option of converting all or just some of your accounts.
- Contact your current brokerage and let them know you want to initiate a rollover.
- Your brokerage will send you a distribution check made payable directly to you for the amount you decide on. You have 60 days from when the distribution is made to put those funds into a Roth IRA.
Contact your brokerage and ask them to transfer the money to the trustee of your Roth IRA. Depending on the financial institution’s practices, you may be able to do this online. Or they might issue you a check payable to the new trustee.
This is for people who have all their accounts at the same financial institution.
Tell your trustee to transfer a set amount from your old account to your Roth IRA. They will make the transfer.
Remember: You can convert all or part of non-Roth IRA retirement accounts once you leave your job. You might even be able to do it while you’re still employed — it simply depends on your retirement plan. Some plans offer what is called an “in-service distribution.” This is for people to initiate a conversion while they remain at the same job.
Roth Conversion Caveats
Now that we know how to make a Roth conversion, it’s important to take some time and think about what it can mean for your money. There are a few big things to know before you take this step.
First and foremost, the newest tax bill changed a line in the tax code that allowed people to re-characterize their Roth conversions to traditional IRAs. Before 2018, people who converted traditional IRAs to Roth IRAs were able to change their mind and revert it until October 15 of the next year. That’s no longer an option. Once you convert, it’s converted forever.
Second, there’s a five-year holding period on any withdrawals that come from a Roth conversion. The holding period begins on January 1 of the year you make the conversion. Even if you actually convert in October 2018, the start time for your five years is considered to be January 2018.
Third, taxes are a big part of Roth conversions. You must report all conversion amounts from any retirement account as income on your taxes. (The exception is if the conversion is from the designated Roth account.) If you don’t pay attention to how much you convert and which tax bracket that puts you into, you could easily end up with a larger-than-expected tax bill. It’s a good idea to have money outside your conversion account to pay for a larger tax bill.
As with all things, doing your own research is a great idea. Particularly when it comes to the legal and tax implications of moving money around. You should consult with a tax professional about your Roth IRA conversion. You’ll want to make sure everything is square with Uncle Sam when you make this move.
You can also consult the IRS website on this process if you want more information. Ultimately, this decision will matter most to you. You should make it based on how much money you make and what tax bracket a conversion will put you into.
For those of you who want to go a step further, check out this article on how to convert to a Roth IRA without losing money or paying taxes.