Roth Conversion: A strategy to consider

October 30, 2023

A Roth Conversion is a strategy where an investor can convert money and/or investments from a tax-deferred retirement account, or Individual Retirement Account (IRA), into a tax-free retirement account, or Roth IRA.  The process itself is easy enough, but this transaction doesn’t come without its tax consequences as the money and/or investments converted are taxed as ordinary income.  So why and when would you want to perform a Roth conversion or perhaps multiple Roth conversions, it depends on what you are trying to accomplish.

Reducing your Required Minimum Distribution (RMD)

While working you have the option of contributing to your employer-sponsored retirement account, also known as a 401k/403b.  If you contributed to your employer-sponsored plan throughout your working years then upon retirement you probably had a sizeable amount saved.  Under current IRS regulations at age 73 and beyond you are required to take out a distribution of some of your retirement money and pay taxes on it, this is known as a Required Minimum Distribution (RMD).  But what if you could reduce the amount in your retirement accounts before turning age 73 which would also reduce the amount you would need to withdraw to satisfy your RMD? 

Upon retirement, you will most likely fall into a lower tax bracket as your income will most likely decrease given you are no longer receiving a paycheck.  This creates an opportunity for converting from IRA to Roth in the years between retirement and before turning RMD age.  By taking on taxable income during this time your income would be taxed at a lower rate.  You would also be moving money from your IRA where there would be an RMD requirement into a Roth IRA where there would be no RMD requirement along with allowing your money to grow tax-free.  You should consult with your tax advisor to understand how performing a Roth conversion could impact your personal tax situation.


Wealth Transfer

As you meet with your financial advisor he or she may talk to you about how a Roth conversion could also be part of a wealth transfer strategy which would provide a tax benefit to your heirs.  This pertains to understanding the types of accounts you hold your investments in and how those accounts would be treated from a tax perspective upon inheritance.  Inheriting a 401k/403b or IRA would require your heirs to take on the tax burden of withdrawals from these accounts i.e., every dollar they withdraw would be taxable to them.  By converting into a Roth IRA your heirs would have the ability to take withdrawals tax-free.

IRS regulations require certain beneficiaries to take distributions from a Roth IRA they inherit.  The distribution options available depend on the relationship the one inheriting the Roth has to the original owner, these categories include Spousal Beneficiary, Eligible Designated Beneficiary, and Non-Spousal Beneficiary.  You should consult with your financial advisor to understand which category your beneficiaries fall under and therefore what their distribution options would be upon inheriting your Roth IRA. 

Gottfried & Somberg Wealth Management, LLC does not provide legal or tax advice. You should consult a legal or tax professional regarding your individual situation.