Roth IRA Conversion – What You Need to Know Before Converting

Roth IRA Conversion – What You Need to Know Before Converting

Hi there and thank you for stopping by. Today I’m going to talk about converting dollars from your traditional IRA to your Roth account, also known as Roth IRA conversions. My name is Tina Anders. I am the fee only Certified Financial Planner for my wealth management firm, located here in Petaluma, California, Anders Wealth Management serving clientele primarily in the Sonoma and Marin counties. Thank you again for stopping by.

So, let’s talk about Roth conversions. So, Roth conversions turn traditional IRA dollars into Roth IRA dollars. Which can bring long term tax benefits, but you may face a tax bill in the year you convert. Why would you do a Roth conversion? You would do a Roth conversion to have avoid having to take RMD’s, also known as a required minimum distributions at age 72 mandated. And then you would end up paying ordinary income taxes on the RMD’s. So, a Roth conversion allows you to avoid that, also to avoid having to pay any taxes on your Roth IRA distributions, moving traditional to Roth. And then also, if you think your tax rate in retirement will be higher than it is now. Those are some reasons to do a Roth conversion.

Here’s how it works. Say you have a traditional IRA funded. Move your traditional IRA dollars, the desired amount, to your Roth IRA. Pay taxes on your IRA contributions and gains. So, when you move money from a traditional IRA to a Roth IRA, you will be taxed. If the contributions to the traditional IRA are tax deductible, you will be taxed on the money that has moved over from traditional to Roth.

To reduce the taxes you’ll owe on the rollover. Time your conversion in a year for instance that you’re in a lower tax rate, perhaps your income is going to drop or has dropped, and you anticipate a lower tax bracket in that year. Good time to do a Roth conversion or when your traditional IRA account is down. Because, for instance, in the COVID volatile market, perhaps your IRA balance is lower. Thereby when you move the balance over to the Roth, it’s not as high as it would have been, so your tax liability will also be reduced. Also, time it as you can afford to pay the taxes. You don’t have to convert your full balance. Think about converting only the mount on what you can afford paying taxes.

So, how do you convert traditional IRAs to Roth IRAs? There are three different ways. One is an indirect rollover, in which case, you personally and I don’t recommend this. But you personally take a distribution from your traditional IRA, and then you contribute it to your Roth IRA within a 60-day window. Be careful, I don’t recommend doing it this way. That is one way you can do it.

Another way is a trustee to trustee transfer. You tell your financial institution that has your traditional IRA to transfer money directly to your Roth IRA, perhaps at a different institution. That’s a trustee to trustee or direct rollover.

And another way to do a Roth conversion is to do a same trustee transfer which if your traditional IRA and your Roth IRA are held at the same institution, just call your institution and tell them I want to roll or convert this much from my traditional to my Roth, and they will handle that for you.

So, a Roth IRA, conversion might be wrong for you, if you lack the cash to pay the likely tax bill is generated by the conversion. Some people pay the tax bill with part of the conversion, the converted balance, but that sacrifices some of the tax-free investment growth.

If you’re under 59 and a half, you might not want to do a Roth conversion because you might have to pay a 10% penalty on the money that you convert. You also might not want to do a Roth conversion if you need the money in the next five years. Because withdrawals of money from the conversion of a traditional IRA or a 401k to a Roth are subject to a five-year waiting period to avoid a penalty. So, each conversion or rollover you make is subject to a separate five year waiting period. So, be careful about that.

Another reason not to do on is if the rollover will subject you to a higher marginal tax bracket in the year that you make the conversion. So I have clients send me a password protect protected PDF of their recent tax returns, so that we can pop it into my software to project how much they can afford to convert to a Roth IRA without putting them into a higher tax bracket. So, please be sure to run these projections before you make your decision. Because a larger than necessary tax bite can really hurt. In some a Roth conversion could be right for you if you like the idea of your investment earnings growing tax free. If you want the ability to lower your taxable income in retirement. If you think maybe your tax rate in retirement will be higher than it is now. Or and or if you want to avoid required minimum distributions, which the IRS mandates at age 72 from a traditional IRA.

Thank you for stopping by. If you have a comment or a question, if there’s a topic on which you’d like me to do a video, please comment below and I will do my best to accommodate you. Tina Anders here in your corner. Thanks again.

What Is A Backdoor Roth IRA?

What Is A Backdoor Roth IRA?

Hi there and thank you for stopping by. My name is Tina Anders and I am the Certified Financial Planner for my firm here in Petaluma, California, Anders wealth management. I appreciate you taking the time to learn a little bit today about Backdoor Roth IRAs, and even better Mega Backdoor Roth IRAs. First, let me just tell you, we’re filming at home because of COVID. So, please bear with me.

Backdoor Roth IRA contributions. Okay, so that’s an IRS sanctioned method for high income taxpayers to fund a Roth IRA even if their income is higher than the maximum IRS allows for regular Roth IRA contributions. Non-deductible traditional IRA contributions can be rolled to your Roth IRA. That’s a backdoor Roth IRA.

If your income exceeds the limits the IRS is placing on you so that you can’t contribute to a Roth IRA. That’s okay. Because you could put in non-deductible traditional IRA contributions in your traditional IRA, and then you can roll that to your Roth. That’s one way to do a backdoor Roth IRA contribution.

But let’s talk about something else called the Mega Backdoor Roth IRA contribution, which is amazing. So, let me ask you a couple questions. Do you know if your 401k plan, this is a plan at work, employer sponsored retirement plan? Do you know if your 401k plan allows you to make after tax 401k contributions? I’m not talking about Roth contributions; I’m talking about after tax non tax deferred traditional 401k contributions. If so, does your employer do separate accounting of the pretax and post-tax contributions? If so, are you allowed to take in service withdrawals during your employment? Okay, so if you answer yes to these questions, you may want to consider a Mega Backdoor Roth. Because really, I like for you to get as much money into a Roth IRA as soon as possible to get as much tax free growth for as long as possible. And the way to do this is to make after tax payroll deferrals into your 401k.

Regarding these after-tax contributions or deferrals to your 401k account, if your after tax contributions accumulate investment earnings, the IRS said it’s okay to split up the money between the contributions and their earnings. So, you can put the contributions, you can roll them straight into a Roth IRA, and the earnings go into a traditional IRA. Okay?

Now let’s remember Roth IRAs are tax free with a few rules, one of which is you have to have held it for at least five years. You can’t take money out penalty free before the age of 59 and a half. There are other rules that go along with these rules, but I’m not going to go into those today, I want to talk about who’s prohibited from doing a Mega Backdoor Roth conversion and that is a highly compensated employee. And that’s a person who either owns more than 5% of the interest in the business at any time during the year or the preceding year, or they receive compensation from the business for more than $125,000 in 2019 or $130,000 in the year 2020. And if the employer so chooses, they can say that the top 20% of employees ranked by compensation are highly compensated employees. So just be careful if you’re highly compensated employee, you don’t want to do a Mega Backdoor Roth IRA.

The other thing I want to mention is, and this is the good news, when you find a traditional or a Roth IRA under normal circumstances, you’re putting in $6,000 a year $7,000 a year, right in there depending on what year it is and what the rules are. But in 2020, the maximum you and your employer combined can put in your 401k is $57,000. If you’re under the age of 50, guess what? If you’re 50 or older, you can put in a total of $63,500 into your employer sponsor 401k accounts, which includes all contributions to include employer contributions. So, don’t go over the limits. Talk to your employer, HR department about this, and see if there are ways for you to do a Mega Backdoor Roth IRA. A fantastic saving tool, a fantastic tax liability relief tool.

Thank you again for stopping by today. Hey, if you would like me to speak about any particular topic on a video or if you have a question or a comment, please go to my website, Go to the contact page. Fill out as much or as little as you want. But in the bottom of the contact page, there’s a text box, fill out anything you would like to share with me that you could use my help on. You want to have me speak on a video and I will do what I can to help out. Thanks again. I am in your corner.