By Jeffery O’Neal, Financial Advisor
Depending on your situation, it might be appropriate to make some year-end financial moves. But there’s one in particular that may allow you to take advantage of the current investment climate while providing potential benefits far into the future.
This move is called a Roth IRA conversion — the process of converting all or a portion of a traditional IRA to a Roth IRA. Traditional IRAs are often funded with pre-tax dollars, so contributions can lower your taxable income, and earnings can grow tax deferred. A Roth IRA, however, is funded with after-tax dollars, so you get no immediate tax deduction, but earnings and contributions can be withdrawnfederally tax free, as long as you meet several requirements, including holding your account for five years and not taking withdrawals until you’re at least 59½.
If you’re attracted to the prospect of tax-free withdrawals in retirement, you might consider converting some or all of your traditional IRA dollars to a Roth IRA. Yet, there’s one major issue to address: taxes. Any deductible contributions to your traditional IRA, and the earnings generated by these contributions, will be fully taxable the year of the conversion. If you’ve invested in your traditional IRA for many years, this tax bill could be considerable.
But if you were interested in converting some of your traditional IRA funds to a Roth in 2022, you might have one advantage, tax-wise — and that’s the state of the financial markets. As you are no doubt aware, it’s been a rough year for stocks, so the value of some of the investments in your traditional IRA may have fallen, perhaps substantially. If you were to convert these assets to a Roth IRA, your tax bill might be quite a bit lower than it would have been last year amid the lengthy bull market.
Still, lower taxes aren’t the same as no taxes. Ideally, you probably don’t want to take money out of the IRA itself to pay the taxes, since this might reduce some of the benefits. So, if you don’t have another source from which you can draw, you may find that a conversion might not make as much sense.
However, you could lower this tax bill by making smaller conversions over several years. And you might ultimately find this strategy worthwhile, because moving from a traditional IRA to a Roth IRA can offer some advantages. For one thing, since qualifying Roth IRA withdrawals won’t be counted asincome, they won’t cause additional taxation of your Social Security benefits or bump up your Medicare premiums. (If you wait until retirement before making the conversion, the conversion itself could have these effects, at least for the years in which it takes place.)
Also, with a traditional IRA, you typically must start taking withdrawals once you reach 72, but a Roth IRA doesn’t have this requirement. So, if you don’t need all your Roth IRA funds to support your retirement lifestyle, you can pass the reminder, tax free, to your beneficiaries. Consequently, a Roth IRA can play an important role in your estate planning.
Whatever the benefits of a Roth IRA, it’s essential that you consult with your tax advisor before making a conversion decision. It’s a big move — so you’ll want to be sure it’s right for you.
This article is provided by Jeffrey O’Neal, Financial Advisor
Edward Jones
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