Guide: How Do I Convert my IRA & 401K Accounts to Roth?

Do you feel you have taken the steps to ensure your financial future, having an IRA and/or a 401(k) account? Do the new tax laws throws a wrench into your plan, making the conversion to a Roth IRA seem beneficial? You may think the Roth IRA sounds like a viable option, but you have a variety of questions. Should you convert all your money to a Roth IRA account? What are the steps, benefits, and drawbacks to the conversion process? Is this the right move for my portfolio considering my investments and my age?

What Is the Problem with Conversion?

When you switch from a traditional IRA or 401(k) to a Roth IRA, the actual process is relatively easy, the process involves some paperwork and some signatures. You can conveniently convert any account and any amount, even one dollar, over to a Roth IRA. The major problem barreling down in the form of a tax bill —how much you pay and when. Essentially, you have to pay taxes on the principal amount you are converting, as they were initially pre-tax investments. These taxes could pose a roadblock if you are experiencing a lull in steady employment, have a pile of bills and debt to pay, or another variation of a financial hiccup.

Overcoming the Problem for the Greater Financial Good

Right now, the tax rates are low for all income levels, based on the current administration’s new tax laws. Therefore, a window of opportunity exists for you to take advantage of the lower taxes on your conversion amount. Below are a few additional strategies that may help make the conversion tax more feasible for your financial situation.

  • Remember the old cliché about the value of moderation? This cliché’ is applicable here. You can spread the amount you want to convert over a period of time. Because the converted amount is added to your annual income amount, or gross adjusted income, you want to convert a sum that allows you to maintain your tax bracket. If you move to the higher tax bracket tier, you will be subjected to a higher tax rate. Depending on how much money you want to convert and where you stand within the tax bracket, you may have to convert money for quite a few years. However, with the new tax laws in place, you can expect lower tax percentages for at least another three to seven years. Therefore, you can find lower tax rates at all income levels. Looking past that beginning in roughly 2026, financial advisors predict an increase, even a doubling, of tax rates.
  • To minimize the tax impact, you can also consider a tax-deductible donation to a public charity. The deduction you receive could be as much as 60% of your adjusted gross income. Remember that this amount could increase in the future when tax rates are higher.

Keep in mind that with the traditional IRA/401(k) to Roth IRA conversion, you are moving your money from a taxable to a tax-free account. This is for the overall benefit of your retirement portfolio, so this initial tax hit may be for the long term greater good.

Diversification is Key

You have probably heard about the importance of a diversified financial portfolio. Diversification obviously refers to the types of companies in which you invest, but it also refers to the types of accounts you have. Balancing traditional IRAs with Roth IRAs allows you to balance when you pay taxes. As discussed above, Roth IRAs require taxes upfront on the principal, and traditional IRAs impose taxes on the withdrawals, a.k.a. required minimum distributions, you make starting at age 70.5. Moreover, based on your income, you are limited in the amount of contributions you can make to a Roth IRA, but no contribution limits exist with a traditional IRA. Since the two types of IRA have opposing characteristics, you can see why it would be valuable to partake in both types.

Trust Your Gut and Your Advisor

The strategy that is right for you depends on your current and projected financial situation. People have all types of job circumstances, sources of income, and expenses. Therefore, no one perfect strategy exists. Regardless of where you stand on the financial tier, it is recommended that you take an active, tactile approach to tax and investment planning. Ultimately, you want to mitigate future risks and protect your retirement. Only you know what you can handle, and a financial expert here at Wright Wealth Management Group can help you find the right program or strategy to reduce the conversion tax. Regardless of where you stand on the financial tier, it is recommended that you take an active, tactile approach to tax and investment planning. Ultimately, you want to mitigate future risks and protect your retirement.