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Roth Conversions – is this the right time to pull the trigger?

Has the recent dip in the stock market caused your retirement account to lose value?

This could be the perfect time to take advantage of converting your traditional IRA to a Roth IRA and save on the income tax owed.

What is the difference between a traditional and Roth IRA?

The main differences between a traditional and Roth IRA deal with the tax implications of both the deductibility on your tax return and the timing of when the income tax is paid.

Traditional IRA

Contributions to a traditional IRA are generally deductible on your tax return, subject to limits based on your modified adjusted gross income and whether you (or your spouse) participate in a qualified retirement plan, such as a 401(k).

Tax is deferred……or in ither words, you must pay income tax at the time of eventual withdrawal. Although there are a few exceptions for early withdrawal without penalty, if you would like to withdraw the money before age 59 ½, you will be penalized. Traditional IRAs do require you to take a required minimum distribution (RMD) after the age of 72 or you will also be penalized (i.e., for failing to take your proper RMD).

Roth IRA

Unlike traditional IRAs, Roth IRA contributions are never deductible on your tax return. However, withdrawals are tax-free as long as you are 59 ½ or older and the account has been open at least five years. Contributions can be withdrawn at any time, income tax and penalty free. Even better, there is no required minimum distribution requirement with a Roth IRA once you reach age 72.

Although contributing to a Roth IRA is subject to modified adjusted gross income limits, you are able to convert a traditional IRA to a Roth, no matter how high your income is.

Tax consequences of the conversion

Since tax is deferred with a traditional IRA and tax is paid up-front with a Roth IRA, it is only fair that with a conversion from a traditional IRA to a Roth, there is generally some tax due that is based on the amount being converted.

Is a Roth conversion right for you and when to do it?

Before you decide to convert your traditional IRA to a Roth IRA, you should consider the tax bill you might face and your future retirement plans. Do you have other available cash on hand to pay the income tax due upon Traditional-to-Roth conversion?   How much to convert is also a factor.  You could decide to only convert a lump sum or only a portion of your traditional IRA-to-Roth;  furthermore, you may convert smaller amounts over a 5-10 years; this allows you to spread the income and the related tax due over the same period of time.   Your anticipated retirement age could also be a driving factor as you consider the best time and dollar amount to convert to a Roth.

There are a lot of factors to consider before deciding if converting your traditional IRA to a Roth IRA is tax-wise and an overall benefit to your overall financial goals. Please contact your Wegner tax advisor to discuss and run some tax projections of possible IRA-to-Roth conversion.   Note: the conversion must occur by December 31, 2022 in order for it to impact your 2022 tax return.

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