How to Understand Roth IRA Conversions: A Guide for Beginners

05-02-2023

Skip West thinks that a Roth IRA change can be a useful tool for people who want to get tax-free income in retirement. During a Roth IRA conversion, money from a regular IRA or other pre-tax retirement account is moved into a Roth IRA, where it can grow tax-free and be taken out tax-free in retirement. A Roth IRA change can be a smart financial move for many people, but before deciding to convert, it's important to know how it works and what might happen.

First, it's important to know what makes a standard IRA different from a Roth IRA. Donations to a traditional IRA can be made with money that hasn't been taxed yet. This lowers the amount of taxable income in the year that donations are made. Withdrawals from a standard IRA, on the other hand, are taxed the same way as other income. On the other hand, Roth IRAs let you put in money that has already been taxed, but qualified transfers in retirement are tax-free.

When a standard IRA is changed to a Roth IRA, the money is moved from a pre-tax account to an after-tax account. This means that taxes will have to be paid on the amount that was changed in the same year that it was changed. Before you decide to convert your Roth IRA, you should carefully think about how it will affect your taxes.

The timing of the change is another thing to think about. If a person thinks they will be in a higher tax bracket in retirement than they are now, converting a standard IRA to a Roth IRA can be a good idea. But you should also think about the short-term tax effects of a conversion and how it might affect your ability to get certain tax credits and benefits.

There is more than one way to convert a Roth IRA. One choice is a straight conversion, in which the money is moved from the traditional IRA to the Roth IRA. Another choice is an indirect conversion, in which the money is taken out of the standard IRA and put into the Roth IRA within 60 days. It's important to keep in mind that you can only make one indirect change per year.

It's also important to think about how a Roth IRA change could affect your future income in retirement. Even though a Roth IRA can give you tax-free income when you retire, the tax savings you get from converting it may not be enough to cover the taxes you owe in the year you convert it. Also, a Roth IRA conversion can change the amount of RMDs (required minimum distributions) that must be taken from the account when you leave.

In the end, converting a traditional IRA to a Roth IRA can be a smart financial move for many people. However, before deciding to convert, it's important to think carefully about the tax implications and how it might affect your future retirement income. Working with a financial expert can help people understand the pros and cons of converting their Roth IRA and help them decide if it's the right move for their finances.