How to Convert to a Roth IRA: A Primer

05-02-2023

As explained by Skip West, a Roth IRA conversion is a helpful strategy for those who desire to receive tax-free income in retirement. Converting your pre-tax retirement savings into a Roth IRA allows you to grow your money tax-free and withdraw it tax-free in retirement. Although converting to a Roth IRA may be financially advantageous for some, those thinking about making the switch should first familiarize themselves with the conversion process and any potential consequences.

To begin, it's crucial to differentiate between a standard IRA and a Roth IRA. Pre-tax monies contributed to a traditional IRA will reduce your taxable income in the year in which the contribution is made. Withdrawals from a traditional IRA, however, are subject to ordinary income taxation. Contributions to a Roth IRA are made with after-tax earnings, but withdrawals that meet certain criteria in retirement are not taxed.

When you switch from a standard IRA to a Roth IRA, your money goes from a tax-deferred to a tax-free account. As a result, you'll have to pay taxes on the converted amount in the same year you make the conversion. Before deciding to convert your traditional IRA to a Roth IRA, you should research the tax consequences of this move.

When to make the change is yet another consideration. Those who anticipate being in a higher tax bracket in retirement may benefit from converting their regular IRA

to a Roth IRA. However, you should think about the potential impact on your eligibility for certain tax credits and deductions and the short-term tax implications of a conversion.

A Roth IRA conversion can be made in a number of different ways. A direct conversion is one possibility, in which the money goes straight from the regular IRA to the Roth IRA. Indirect conversions are also possible by withdrawing money from a regular IRA and putting it into a Roth IRA within 60 days. One indirect conversion per calendar year is the limit.

The effect of a Roth IRA conversion on your retirement savings is another factor to think about. While it's true that withdrawals from a Roth IRA won't incur taxes once you're retired, the tax savings from the conversion might not be enough to cover the taxes you'll owe this year. Required minimum distributions (RMDs) are withdrawals made from a traditional IRA after retirement that may be affected by a conversion to a Roth IRA.

While converting to a Roth IRA may be financially advantageous for some, doing so involves serious thought because of the tax consequences and the potential impact on future retirement income. An individual's financial situation will dictate whether or not a Roth IRA conversion is the best course of action, but working with a financial advisor can help weigh the benefits and drawbacks.