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> Roth IRAs and Roth Conversions

Enjoy tax free income during retirement! 

Every dollar can matter when you’re retired. A Traditional IRA is the most common retirement planning vehicle; however, another option is a Roth IRA. Roth IRA’s are a retirement planning tool where contributions are made with after tax dollars, making your withdrawals during retirement tax-free.  Roth IRA’s are not subject to required minimum distributions, so if you don’t need the money every year, you can let your Roth IRA continue to grow, tax-free. 

If you are thinking of opening a Roth IRA, please note there are salary limitations, along with annual contribution amounts based on your earned income.  For 2023, the modified adjusted gross income (MAGI) limits are less than $153,000 for single tax filers and less than $228,000 for married filing jointly. Annual individual contributions are $6,500, and if you are 50 years of age or older, you may contribute up to $7,500.
When opening your Roth IRA, it is important to be aware of the five-year clock. What is a five-year clock?  The five-year clock is when you make your first contribution to open your Roth IRA.  The clock begins ticking on the first day of the tax year, even if your first contribution is not made until August. This is important because when you’re ready to spend some of your Roth IRA, certain conditions must be met to avoid being taxed.  The owner must be 59 ½ years of age AND the Roth IRA must have been open for at least 5 years (i.e. the five-year clock).  

Many employer sponsored retirement plans are now providing a Roth 401(k) option.   Your Roth 401(k) plan and your personal Roth IRA do not share the same five-year clock.  It is recommended that if you are participating in an employer sponsored Roth 401(k) plan, and if you qualify, you should establish an individual Roth IRA. 

We recommend you consider rolling over your Roth 401(k) into your individual Roth IRA upon retirement. Caution!  The five-year holding period associated with the Roth IRA overrides your Roth 401(k) holding period. If have owned your Roth 401(k) for 10 years and did not open a Roth IRA, when you are ready to rollover your Roth 401(k) into a Roth IRA, the five-year clock begins that tax year. Again, Caution!  This could make a difference if you are entering retirement and have not met the two conditions of being 59 ½ years of age, and have not satisfied the five year clock. 

Do you like the idea of having more tax-free income in retirement? You may want to consider a Roth conversion. Why should I think about a Roth conversion? 

If approaching retirement and you have most of your retirement assets in a Traditional IRA, every distribution will be considered taxable income.  A Roth conversion might be the right option for you. As mentioned earlier, as an owner of a Roth IRA, you are not subject to required minimum distributions. 

When making a Roth conversion, monies from a Traditional IRA are transferred into a Roth IRA.  This transfer is considered a taxable event.  It is recommended that you pay the tax on this income from other post-tax accounts (for example, personal savings), rather than taking further taxable distributions from your IRA.
It is not necessary to convert your entire IRA all at one time, rather you can do periodic Roth conversions over several years to spread out the additional taxable income.  This is a cost-effective way to build post-tax dollars for retirement.   

In most circumstances, it’s never too late to do a Roth conversion.  Converting Traditional IRA funds to a Roth IRA allows the Roth to continue to grow tax free.  

Another benefit of a Roth conversion came via the Secure Act 2.0.  Beneficiaries who inherit a Traditional IRA account from a parent (under most circumstances) are required to withdraw the entire Traditional IRA within a 10-year timeframe.  This could create an undue tax burden on the beneficiary and send a good portion of the Traditional IRA to the government in tax payments.  This is not the case for the Roth IRA.  When a Roth IRA is inherited from a parent, there is the 10-year distribution requirement, but every dollar distributed to the beneficiary is tax-free! 

Lastly, and most importantly, for those retirees taking Social Security, taking distributions from a Traditional IRA will create more taxable income.  This additional taxable income may cause an increase in the Medicare surtax charges on your Medicare Part B and D premiums.  Another great reason to consider a Roth IRA!
Fun Fact:  The term Roth came from a Delaware senator, William V. Roth Jr.  The Roth IRA became available in 1998 as part of the Tax Relief Act of 1997.  

Diane DeStefano 
Senior Financial Advisor, CFP®, CTFA

Karen Crump
Senior Financial Advisor

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