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Reasons to Consider Switching Your IRA to a Roth

February 02, 2023

An excellent retirement option for many to consider is a Roth IRA. With this type of account, withdrawals are tax-free, but contributions are not tax-deductible. This offers the opportunity for significant investment profits that won't be taxed during the course of the account.

A standard IRA, in contrast, permits tax breaks on contributions but taxes withdrawals at a later time. Although there are income limitations for Roth direct donations, there are none for IRA conversions to Roth accounts. You can convert all or a portion of your IRA into a Roth IRA when the conditions are appropriate, pay taxes on the transferred amount, and take advantage of tax-free withdrawals from the Roth IRA. Many recommend that taxes be paid in cash, not with IRA savings, for maximum benefits.

Here are two points to consider converting to a Roth IRA:

You can spread your taxes using a Roth IRA.

When using a Roth IRA, tax diversification can be helpful. This way, you can evaluate your tax status annually and choose which account to withdraw funds from based on your requirements. For instance, Medicare rates rise after a certain income level is reached. If your taxable income is approaching one of these thresholds, but you still need to pay expenses, taking money out of a Roth IRA could be a good course of action. You'll be able to pay your bills, receive your money, and avoid paying higher Medicare premiums.

Beneficiaries may not get taxed using a Roth IRA.

The SECURE Act changed how non-spouse beneficiaries inherit IRAs, which Congress approved in 2019. Before this legislation was passed, a non-spouse beneficiary could inherit an IRA and take withdrawals for the rest of their life. For a long time, this made the tax burden more tolerable.

The SECURE Act now mandates that these recipients liquidate the whole IRA within ten years. Whether given over time or taken out in one lump sum payment, there is now a smaller window within which that money must be withdrawn and taxed.

Due to the shorter term, these bigger withdrawals are more likely to put their recipients in higher tax brackets. Even though a Roth IRA must still be withdrawn after ten years, your beneficiaries won't be subject to taxes on their income.

Changes to your tax filing status can make an impact.

The greatest time to look into Roth IRA conversions is when you are in a lower tax bracket. Income levels are typically the root of this, but another important factor that may change at some point is your tax filing status. Compared to married couples who file individually, married couples who file jointly have larger incomes at lower rates.

Although widows have a two-year grace period, death or divorce may cause this transition and force you into a more expensive tax bracket due to a less forgiving filing status.

While no one plans for it to happen, there are some circumstances when it might be something to consider, particularly for spouses with a significant age gap who may not want to remarry.

The market is losing strength.

While the stock market is down, switching to a Roth account may be a good option. Since the gain is now in a Roth IRA, it will be tax-free in the future, and more shares can be converted at a lower price. If you're executing a partial conversion, you can choose which shares to convert by selecting the stocks you think have the greatest growth potential.

As you can see, considering a Roth conversion has a lot of advantages. However, there is a distinct five-year window for each conversion during which you cannot withdraw the money without paying a 10% penalty. However, a conversion could have a lot of benefits if the money is unnecessary. Please contact us today if you are considering a Roth IRA or have questions about how this financial tool fits into your financial plan.