When you do decide to take distributions from a Roth IRA, you won\u2019t have to pay income taxes on that money. You already paid income taxes before you contributed, remember?<\/p>\n
These are the main benefits of a Roth IRA that set this account apart from a traditional IRA, but there are plenty of others. With all of this in mind, it\u2019s no wonder so many people try to convert their traditional IRA into a Roth IRA<\/a> at some point during their lives.<\/p>\n But, is a Roth IRA conversion really a good idea? This kind of conversion can certainly be lucrative over time, but you should definitely weigh all the pros and cons before you decide.<\/p>\n Converting an existing traditional IRA or another retirement account to a Roth IRA can make sense in many different situations, but not all the time. At the end of the day, the value of this investing strategy depends on your unique situation, your income, your tax bracket, and the financial goal you\u2019re trying to accomplish in the first place.<\/p>\n The most important detail to understand is that, when you convert another retirement account to a Roth IRA, you will have to pay income taxes on the converted amounts. <\/p>\n It can make sense to pay these taxes now to avoid more taxes later on, but that depends a lot on your tax situation now and what your tax situation may be like later in life.<\/p>\n The main scenarios where converting to a Roth IRA can make sense include:<\/p>\n Lifetime tax prior to performing Roth conversions<\/p>\n These are just some of the instances where it can make sense to convert another retirement account into a Roth IRA, but there may be others. Also note that, before you do anything drastic or begin a conversion, it can be smart to speak with a tax advisor or financial planner with tax expertise.<\/p>\n At the very least, be sure to model the conversion as part of a comprehensive written retirement plan<\/a>. The NewRetirement Planner enables you to try out specific conversion strategies in the context of your entire financial situation. Assess the conversion on your tax liability, net worth<\/a> at longevity, and cash flow.<\/p>\n<\/blockquote>\n Considering a Roth IRA conversion comes with immediate tax consequences, there are plenty of scenarios where doing one doesn\u2019t make any sense. <\/p>\n There are also plenty of personal situations where a Roth IRA conversion would likely go against a person\u2019s long-term goals<\/a>. Here are some of the scenarios where a Roth IRA conversion could be a costly waste of time:<\/p>\n Again, these are just some of the scenarios where you would want to think long and hard before converting another retirement account to a Roth IRA. There are plenty of other situations where this move wouldn\u2019t make any sense, and you should speak with a tax professional before you move forward either way.<\/p>\n Or, make sure you fully understand your projected income, expenses, and savings situation before doing a conversion. The NewRetirement Planner gives you a detailed insight into all aspects of your financial future.<\/p>\n Though there are\u00a0income limits that apply to contributing to a Roth IRA, these income limits do not apply to Roth IRA conversions. With that in mind, here are some important Roth IRA conversion rules you need to learn and understand:<\/p>\n While the most common Roth IRA conversion is one from a traditional IRA, you can convert other accounts to a Roth IRA. Any funds in a QRP<\/a> that are eligible to be rolled over can be converted to a Roth IRA.<\/p>\n You can take direct delivery of the funds from your traditional IRA (check made payable to you personally), and then roll them over into a Roth IRA account, but you must do so within 60 days of the distribution<\/a>. If you don\u2019t, the amount of the distribution (less non-deductible contributions) will be taxable in the year received, the conversion will not take place, and the IRS 10% early distribution tax penalty will apply.<\/p>\n This is not only the easiest way to work the transfer but it also virtually eliminates the possibility that the funds from your traditional IRA account will become taxable. You simply tell your traditional IRA trustee to direct the money to the trustee of your Roth IRA account, and the whole transaction should proceed smoothly.<\/p>\n This is even easier than a trustee-to-trustee transfer because the money stays within the same institution. You simply set up a Roth IRA account with the trustee who is holding your traditional IRA, and direct them to move the money from the traditional IRA into your Roth IRA account.<\/p>\n Note that, if you don\u2019t follow the rules outlined above and your money doesn\u2019t get deposited into a Roth IRA account within 60 days, you could be subject to a 10% penalty on early distributions as well as income taxes on the converted amounts if you\u2019re under the age of 59 \u00bd.<\/p>\n And, as we already mentioned, you\u2019ll have to pay income taxes on converted amounts regardless of which rule you choose to follow above. You\u2019ll report the conversion to the IRA on\u00a0Form 8606<\/a>\u00a0when you file your income taxes for the year of the conversion.<\/p>\n<\/blockquote>\n If your income is too high to contribute to a Roth IRA<\/a> outright, the Backdoor Roth IRA offers a potential workaround. This strategy has consumers invest in a traditional IRA first since these accounts don\u2019t come with income limitations in terms of who can contribute. From there, a Roth IRA conversion takes place, letting those high-income investors take advantage of tax-free growth and future distributions without having to pay income taxes later on.<\/p>\n A Backdoor Roth IRA can make sense in the same scenarios any Roth IRA conversion makes sense. This type of investment strategy<\/a> intends to help you save money<\/a> on taxes later at the cost of higher taxes now, in the year you make the conversion.<\/p>\n The big disadvantage of a Backdoor Roth IRA is a whopping tax bill, you\u2019re hoping to lower your tax liability in the future. That\u2019s a noble goal but, once again, the Backdoor Roth IRA only makes sense in situations where tax savings can truly be realized.<\/p>\n<\/blockquote>\n Interested in a Roth IRA, but aren\u2019t sure if it is right for you? Try modeling it in your own plan.<\/p>\n The NewRetirement Planner is the most powerful and comprehensive modeling tool available online. It\u2019s for people who want clarity about their choices today and their financial security tomorrow. It gives people the ability to discover, design, and manage personalized paths to a secure future. Helping you make smart decisions about your money, including whether or not you should do a Roth conversion, is the heart of the tool.<\/p>\n You have two options for how to model conversions in the NewRetirement Planner:<\/p>\n Once you have set up all aspects of your plan (a really thorough inventory of your current and future income, expenses, and savings), you can try modeling a specific conversion that you think would be advantageous.<\/p>\n Lifetime tax after performing Roth conversions<\/p>\n The Roth Conversion Explorer is a modeling tool within the NewRetirement Planner.<\/p>\n If you are not sure when or if you should do a Roth conversion, you might start with this tool. It will analyze all aspects of your plan, running hundreds of scenarios, to generate a conversion strategy that could increase your estate value at your longevity.<\/p>\n The deadline for converting funds from a traditional IRA to a Roth IRA is the tax-filing deadline for the year in which the conversion is made. This is typically April 15th of the following year. This means that if you make a conversion in 2022, the deadline for reporting the conversion on your tax return would be April 15, 2023.<\/p>\n As I mentioned earlier, it\u2019s also important to note that there is a deadline for recharacterizing a Roth conversion, which is October 15th of the year following the conversion. This means that if you converted a traditional IRA to a Roth IRA in 2022, you would have until October 15th, 2023 to undo the conversion by recharacterizing it back to a traditional IRA.<\/p>\n<\/blockquote>\n If you think a Roth IRA conversion would be a good move on your part, here are the steps you\u2019ll want to take.<\/p>\n First, make sure you open a Roth IRA<\/a> with one of the\u00a0top brokerage firms. We think\u00a0TD Ameritrade<\/a> is one of the best Roth IRA providers out there due to the fact you pay $0 per trade and $0 per year. However, you should also check out top Roth IRA providers like Betterment<\/a>, Ally<\/a>, M1 Finance<\/a>, and Vanguard.<\/p>\n Next, you\u2019ll want to initiate a Roth IRA conversion with your traditional IRA or QPR provider. Remember that, if you choose to accept the funds with a check, you have 60 days to move the money into your Roth IRA account. You can also have the funds moved via a trustee-to-trustee transfer or even using the same brokerage account<\/a>, and this is often easier since the move should theoretically be taken care of on your behalf. <\/p>\n The major downside of a Roth conversion is that you will be paying taxes on the amount converted in the current year, and depending on your income tax bracket and the amount you\u2019re converting, the tax bite could be substantial. With that being said, you will hopefully plan your conversion in a year when you\u2019re in a lower tax bracket, or when you have other losses you can use to offset additional taxes caused by the conversion.<\/p>\nTable of Contents<\/h3>\n<\/div>\n
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When Would You Want to Convert to a Roth IRA?<\/h2>\n
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When Would You\u00a0Not\u00a0Want to Convert to a Roth IRA?<\/h2>\n
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Roth IRA Conversion Rules You Need to Know<\/h2>\n
Which Accounts Can You Convert?<\/h3>\n
60-Day Rollover Rule<\/h3>\n
Trustee-to-Trustee Transfer Rule<\/h3>\n
Same Trustee Transfer<\/h3>\n
Additional Details to Be Aware Of<\/h3>\n
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What Is the Backdoor Roth IRA and How Does It Work?<\/h2>\n
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Modeling IRAs in Your Own Plan<\/h2>\n
Model Individual Conversions<\/h3>\n
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Use the Roth Conversion Explorer<\/h4>\n
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The Deadline to Convert a Roth IRA<\/h2>\n
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Steps to Convert an IRA to a Roth IRA<\/h2>\n
1. Open a Roth IRA<\/h3>\n
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2. Transfer Existing IRA Assets to the Roth IRA<\/h3>\n
3. Pay Income Taxes On the Conversion<\/h3>\n
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