Navigating Roth IRA Contributions and Conversions: A Guide for Near-Retirees

By Published On: January 2, 2024Categories: Retirement Planning, Wealth Building4.6 min read

Planning for a successful retirement isn’t just about saving enough money; it’s also about strategizing how you’ll manage income and taxes once you stop working. For those approaching retirement, a Roth IRA can be a powerful tool in this regard, offering unique advantages over traditional IRAs.

However, not everyone is eligible to contribute to a Roth IRA. Fortunately, those who don’t meet the contribution requirements may still be able to capitalize on the benefits of a Roth account by planning strategically.

Advantages of Roth IRAs for Retirees

Before diving into the nuances of Roth IRAs, it may be helpful to understand the potential advantages of these accounts for retirees.

One of the most significant benefits is the ability to make tax-free withdrawals in retirement. Whereas traditional IRA distributions are subject to ordinary income taxes, Roth IRA distributions don’t incur taxes since contributions are made with after-tax dollars.

Furthermore, unlike traditional IRAs, which mandate withdrawals starting at age 73, Roth IRAs don’t have required minimum distributions (RMDs). The absence of RMDs provides flexibility in retirement income planning and can lead to greater tax-free appreciation within the account over time.

Contributing to a Roth IRA

While you must have earned income in the current tax year to contribute to a Roth IRA, that income can’t exceed certain thresholds.

In 2023, single filers with a Modified Adjusted Gross Income (MAGI) above $153,000 and married couples filing jointly with a MAGI above $228,000 are ineligible to contribute to a Roth IRA. These thresholds increase to $161,000 and $240,000, respectively, in 2024.

Due to these income limits, many retirement savers are unable to contribute to a Roth during their peak earning years. However, there’s another way to access the benefits of a Roth IRA through a strategy called a Roth conversion.

Understanding Roth Conversions

A Roth conversion is a strategic financial move that entails shifting funds from a tax-deferred retirement account such as a traditional IRA into a Roth IRA. When you convert funds to a Roth IRA, the amount you transfer is subject to ordinary income taxes in the year you make the conversion.

However, future distributions are tax-free if you’re above age 59 ½ and satisfy the five-year rule. And since Roth IRAs don’t have RMDs, your retirement funds can continue to grow tax-free until you need them.

Why Consider a Roth Conversion?

A Roth conversion is a complex strategy that often requires advanced planning and professional guidance. While it may not make sense for every pre-retiree, there are various reasons to consider a Roth conversion, including:

  • If you expect to be in a higher tax bracket in the future, converting to a Roth IRA locks in the current tax rate on the converted funds, potentially lowering your lifetime tax bill.
  • Unlike traditional IRAs, Roth IRAs don’t require withdrawals at a certain age, which can be beneficial if you prefer to let your funds grow tax-free for as long as possible.
  • Roth IRA distributions don’t count as income when determining Medicare Part B and Part D premiums or the taxation of Social Security benefits, which can lead to lower costs and taxes in retirement.
  • Having both traditional and Roth accounts affords you more control over your tax situation in retirement since you get to decide which accounts to withdraw from based on your tax bracket each year.

Ultimately, a Roth conversion can be an effective way to hedge against the possibility of higher taxes in the future. Given that the United States has a growing national debt balance, Social Security and Medicare funding challenges, and an aging population in need of these entitlement programs, however, it’s reasonable to believe higher tax rates will be necessary at some point to cover these rising costs.

Maximizing the Impact of a Roth Conversion

Like most complex financial strategies, implementation pitfalls can offset the advantages of a Roth conversion. To maximize the potential benefits, consider the following best practices:

  • Review your current and expected future tax brackets to determine if a Roth conversion makes sense. It’s typically more advantageous to convert during years when you are in a lower tax bracket.
  • Plan the timing of your conversion to manage the tax impact. This might mean spreading conversions over multiple years to stay within a lower tax bracket.
  • Be aware of the five-year rule, which requires any converted funds to be in the Roth account for at least five years before you can withdraw earnings tax-free.
  • If possible, set aside enough cash to pay the federal and any state taxes due on the conversion. Using outside funds to pay these taxes can maximize the long-term benefits of a Roth conversion, as the entire converted amount can then continue to grow tax-free within the account.
  • While timing the market isn’t advisable, executing a Roth conversion when the market is down may allow you to convert a larger number of shares or units at depressed prices, paving the way for more significant tax-free growth when the market recovers.
  • To minimize the potential tax consequences of a Roth conversion, consider pairing it with other tax planning strategies—for example, making a meaningful charitable contribution in the same tax year.

CornerCap can guide you through the nuances of a Roth conversion to ensure it’s in alignment with your financial goals and overall tax strategy. Our team of wealth advisors has the experience and resources to help you efficiently integrate this strategy into your financial plan, with the goal of maximizing the potential benefits and setting the stage for a more secure retirement.

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