Is a Roth conversion a logical move for you to make or not? John breaks down the pros and cons of converting money to a Roth IRA in various situations.
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The Bass Lines:
What is a Roth conversion?
- [00:33] – A traditional IRA lets you invest tax-deferred, meaning Uncle Sam collects his cut when you withdraw at a later date. A Roth IRA taxes your contribution, but then all of your growth is tax-free. An easy way to keep it straight is to think of a farmer and his crop. With an IRA, you’re paying tax on your harvest. With a Roth IRA, you’re paying tax on your seed, but then you’re getting to keep your harvest.
Wait. Seriously, what is a Roth conversion, and why are we talking about farmers?
- [1:41] – A Roth conversion allows you to roll your money from a traditional IRA into a Roth IRA. In other words, if you know your traditional IRA’s portfolio is going to continue growing, you can withdraw it from that account, pay the tax on the current growth, and then place it in a Roth IRA. This will allow you to keep your future gains, or harvest, if we’re sticking with that analogy. If you can afford to pay the taxes on your current wealth, this is a great way to continue to grow your nest egg, tax free.
Who does it benefit?
- [3:50] – High-income earners can benefit from a Roth conversion. According to the IRS, if you make too much money (more than $185,000 adjusted gross income if you’re married and filing your taxes together), you cannot contribute to a Roth IRA. You’re only able to contribute to tax-deferred investments (401ks, IRAs, etc…). “But John,” you might say, “that’s downright silly.” You’re right. It is silly. Luckily, there’s no limit now to how much money you can convert to a Roth IRA. If you’re sitting on a pile like Davy Crockett, it might be time to consider a Roth conversion. If you don’t know who Davy Crockett is, I can’t help you, and we’ve failed as an American society.
Who doesn’t benefit from a Roth conversion?
- [8:19] – Generally speaking, the older you are, the less you’ll benefit. If you’re approaching retirement (within 5-10 years), you don’t have that much time to let your nest egg continue to grow. Remember, the Roth IRA is a good fit for those wanting to let their money grow. Furthermore, if you’re approaching retirement, you’re probably in your peak earning years. A Roth conversion is only going to increase your tax bill.
Don’t Try This At Home.
- [9:55] – Trust us, it’s complicated to execute. You want to work with a professional.
Roth conversions are useful tools for protecting your wealth. If you’re young, and you make a lot of money, you might benefit from a Roth conversion, but don’t try it at home. Work with a professional. - Mr. Stillman’s Opus PodcastTweet This