Here’s What Happens When You Convert a Traditional IRA to a Roth IRA

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There are tax implications when you do a Roth IRA conversion. Read on to learn what to expect. 

It’s important to save for retirement no matter what plan you opt to do so in. If you don’t have access to a 401(k) plan through your employer, then you may opt to save for retirement in an IRA instead.

IRAs come in two main varieties — traditional and Roth. And there are pros and cons to both.

With a traditional IRA, you get a tax break on the money you put into your retirement plan. From there, investment gains in your plan are tax-deferred. This means you don’t pay taxes on investment gains year after year, but rather, when the time comes to take withdrawals, which are subject to taxes in retirement.

With a Roth IRA, you don’t get a tax break on the money you contribute to your account. However, investment gains in a Roth IRA are yours to enjoy tax free. And withdrawals are also tax free.

Some savers opt to put their money into a traditional IRA because they want the immediate tax savings. But if you go this route, there may come a point when you decide that a Roth IRA will better serve your needs in retirement.

In that case, you have the option to convert your traditional IRA to a Roth IRA. But you should know that doing so could leave you with a pretty sizable tax bill, so you’ll need to plan carefully for that conversion.

It could pay to move your money over

Not having to pay taxes on your retirement plan contributions could do you a world of good. Many older Americans face financial stress once they stop working and are forced to live on a combination of Social Security and savings rather than an ongoing paycheck. So not having to pay taxes on the money you remove from your nest egg could be a major source of relief.

Furthermore, if you expect to be in a higher tax bracket in retirement than you’re in now, then a Roth IRA could make a lot of sense. Plus, with a Roth IRA, you won’t have to take required minimum distributions from your nest egg, whereas those are required with a traditional IRA. And not having to remove funds from your IRA year after year allows you to keep enjoying tax-advantaged growth on your investments, not to mention potentially leave some of that money behind to your children or other heirs.

How a Roth IRA conversion works

With a Roth IRA conversion, you simply transfer funds from a traditional IRA into a Roth account. You can often do so directly for a seamless rollover.

However, you should know that any funds you move over are taxable the year you do your conversion. And you’ll need to make sure you’re equipped to handle that tax bill.

So, let’s say you have $20,000 in your traditional IRA and you decide to convert that entire sum to a Roth IRA this year. This means you’ll have to pay taxes on $20,000. If your tax rate is 22%, that would leave you owing $4,400, which is hardly a small sum of money.

If you’re thinking about converting a traditional IRA to a Roth IRA, it could pay to consult with an accountant or tax professional and get their advice. They may be able to help you plan for that rollover so the associated tax bill isn’t such a blow.

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