Converting an IRA to a Roth IRA

As retirement planning evolves, many individuals are exploring the benefits of converting traditional retirement accounts to Roth IRAs. With Roth options becoming more prevalent in workplace 401(k) plans, the opportunity to secure a tax-free income stream in retirement is increasingly within reach. If you don’t have access to a Roth 401(k) option at your workplace, converting a non-Roth retirement account into a Roth IRA can be an option.

Benefits of a Roth IRA

Having a Roth IRA offers several significant advantages:

Staying under the IRMAA Limit: The Income-Related Monthly Adjustment Amount (IRMAA) affects Medicare Part B and D premiums. For 2024, the IRMAA limit is set at $103,000 for singles and $206,000 for couples. Exceeding these thresholds results in higher premiums. By using a Roth IRA, which provides tax-free withdrawals, retirees can better manage their income levels and stay under these limits, thus avoiding increased Medicare costs.

Minimizing taxes on Social Security benefits: Social Security benefits may be taxable if your income exceeds certain thresholds. Since Roth IRA withdrawals are not counted as part of your income, they can help keep your taxable income lower, reducing or even eliminating the taxes on your Social Security benefits.

Tax planning advantages: A Roth IRA offers the security of knowing the amount of after-tax money available for expenses without concern for changing tax rates. This can be particularly helpful in a fluctuating tax environment, providing stability and predictability for retirement planning.

Understanding Roth conversion rules

Roth conversion rules allow you to convert a traditional IRA to a Roth IRA by paying ordinary income tax on the amount being converted. This process involves a few key steps:

1. Evaluate tax implications: When you convert a traditional IRA to a Roth IRA, the converted amount is treated as ordinary income for the year. It’s crucial to assess whether you can afford the tax bill associated with the conversion. This requires careful planning to avoid pushing yourself into a higher tax bracket.
2. Timing is key: Consider whether time is in your favor. The longer you have until retirement, the more time your investments have to potentially grow tax-free in a Roth IRA. Additionally, converting in a year when your income is lower can minimize the tax impact.
3. Future income projections: Evaluate whether your income will remain the same or increase in retirement. If you expect higher income levels or higher tax rates in the future, converting to a Roth IRA now could be beneficial.

Practical scenarios for Roth conversions

Several scenarios might make a Roth IRA particularly helpful:

• Expecting higher future tax rates: If you expect that tax rates will increase in the future, converting to a Roth IRA now could result in paying taxes at a lower rate.
• Lower income years: Converting during a year with unusually low income can reduce the tax burden of the conversion.
• Estate planning: Roth IRAs do not have required minimum distributions during the account holder’s lifetime, which can be beneficial for those looking to leave a tax-free inheritance to their heirs.

Considerations before converting

Before deciding to convert your IRA to a Roth IRA, consider these critical factors:

• Affording the tax bill: Ensure you have the financial resources to pay the taxes due on the conversion. Using funds from the IRA to pay taxes can diminish the benefits of the conversion.
• Timing: Evaluate the best time for conversion. Spreading the conversion over several years can help manage tax liabilities and avoid pushing into higher tax brackets.
• Future income expectations: Assess whether your income is likely to increase or stay the same in retirement. If you expect to be in a higher tax bracket later, converting now could be helpful.
• Individual scenarios: Consider any specific circumstances, such as changes in employment, inheritance plans, or health considerations, that could influence your decision.
• Five-year rule: The five-year rule for Roth IRAs requires that each conversion must remain in the Roth IRA for at least five years before withdrawals can be made without penalty. This rule ensures that the converted amount isn’t withdrawn too soon, preserving the tax benefits of the Roth IRA.
• Pro-rata rule: The pro-rata rule applies if you have both pre-tax and after-tax funds in your traditional IRA. This rule requires that any conversion be a proportional mix of pre-tax and after-tax dollars, affecting the taxable amount of the conversion.
• Backdoor Roth IRA: A backdoor Roth IRA is a strategy for high-income earners who cannot contribute directly to a Roth IRA due to income limits. This involves making a non-deductible contribution to a traditional IRA and then converting it to a Roth IRA.

Converting a traditional IRA to a Roth IRA can be a strategic move to help secure a tax-free income option in retirement. By carefully evaluating the tax implications, timing and future income expectations, you can make informed decisions that can help enhance your retirement planning.

Leveraging annuities

Using an annuity within a Roth IRA is a strategic way to create reliable income during retirement. Once you retire or choose to start taking income from your annuity, you receive regular, predictable payments for a specified period or for life.

Learn more about our annuity offerings to see if one is right for your situation.

Ameritas can help

If you don’t have Roth 401(k) options, an Ameritas financial professional can help you decide if using a Roth conversion strategy is a good fit for your situation.

Sources and References:
Guarantees are based on the claims-paying ability of Ameritas Life Insurance Corp.

Withdrawals of annuity policy earnings are taxable and, if taken prior to age 59 ½, a 10% penalty tax may also apply. The information presented here is not intended as tax or other legal advice. For application of this information to your specific situation, you should consult an attorney.

In approved states, annuities are issued by Ameritas Life Insurance Corp. In New York, annuities are issued by Ameritas Life Insurance Corp Of New York.