When planning for retirement, it has long been known that taxation is one of many associated mazes.
Just like the labyrinth of legend, tax law is constantly changing with time and often seems purpose-built to instill confusion. With uncertainty on the horizon and potential rate increases looming, the question on many recent and future retirees’ minds is whether to pay taxes now or pay them later.
The concept of a Roth IRA is nothing new. You pay taxes on income at the time of earning to avoid taxation upon withdrawal. For many, this is a decision that was made early on in their careers and has slowly become more impactful as savings continue to grow.
For those who made the decision to put their retirement savings into a Roth IRA from the start, there isn’t too much to consider. Their taxes are paid, and the account balance they see upon withdrawal is what they get, plain and simple. But what about those who elected not to use a Roth IRA for some or all of their retirement savings? Should they consider conversion?
If you chose not to pay income tax as you earn and are waiting until retirement, you might not have considered changing your mind. For many, this makes sense. Targeting a percentage of your pre-retirement income to live on throughout retirement is a very common strategy, after all. If your retirement income is less than your income while earning, you can pay a lower tax rate. However, that relies on the tax rate of your retirement income remaining lower than the rate you would pay as you’re earning. And as any shrewd investor knows, nobody can predict the future.
That’s not to say that there are no factors that are well within your control that are useful in making this decision. In fact, most Roth IRA conversions are the result of changes to one’s personal financial situation, not a reaction to a potential change in the overall financial landscape.
Some of the reasons you might choose to convert to a Roth IRA are:
Similarly, there are also reasons to avoid a Roth IRA conversion. It might not be your best option if:
Recently, there has been a spike in interest among retirees regarding Roth IRA conversion resulting from rumors, reports, promises and other speculation about the future of taxation on retirement wealth. The reality of the situation is that only you and your financial advisor can determine the right path for your retirement. Make sure that if you do decide on a Roth IRA conversion, it’s for the right reasons. Changes in the system are only one factor in your financial situation, your retirement and your choices.
Raymond James and its advisors do not offer tax advice. You should discuss any tax matters with the appropriate professional.
Unless certain criteria are met, Roth IRA owners must be 59 ½ or older and have held the IRA for five years before tax-free withdrawals are permitted. Additionally, each converted amount may be subject to its own five-year holding period. Converting a traditional IRA into a Roth IRA has tax implications. Investors should consult a tax advisor before deciding to do a conversion.