ROTH IRA Conversions

0:00 Ralph: We received this call about Roth IRA conversions. CALLER: Hey, Ralph, I have been thinking about converting my traditional IRA accounts to Roth IRA accounts, but I have been told there are some pretty steep tax consequences to these conversions. I am convinced that taxes are going to have to go up in the future, so I really think converting these IRA accounts is the right thing to do. But I also don't want to make a huge mistake. Please tell me your thoughts and I will decide what is best to do moving forward. Ralph: Are you wondering if a Roth IRA conversion is right for you? We'll stay tuned. As we dig into this important retirement planning topic on today's episode of the ask, Ralph podcast, mastering your finances with a Christian perspective.

1:17 thank you for joining us on this tax talk Thursday today, we're tackling a complex, yet critical retirement planning move. That's the IRA conversion to a Roth. Converting your traditional IRA to a Roth IRA could provide huge tax savings and growth potential in retirement. But it also involves paying taxes upfront and understanding the ins and the outs of Roth rules. So should you convert or not? Well, it depends on your unique situation and financial goals. And this episode we'll explore what a Roth IRA conversion is, who can benefit from converting. When is the best time to convert and a step-by-step set of instructions for completing a conversion.

1:57 My goal today is pretty simple. I want to equip you with the knowledge to determine if a Roth IRA conversion aligns with your retirement vision and walk you through the process smoothly. We'll also discuss how to take this major financial move to God in prayer and discern his wisdom. Well it's a cool and rainy morning today on the farm. As I record this, the cows are hunkered down on their winter pad and enjoying some grass hay, and still looking forward to the promise of a spring day to get back onto that pasture grass. I guess they're going to need to be a little more patient. Well don't forget to subscribe to our show and join our email list. You do that at askralphpodcast.com . So you don't miss tomorrow's show when we discuss admitted versus not admitted insurance companies.

2:38 My cousin lives down in South Carolina and he asked me to do a deep dive on this difference. They've seen a real increase in their insurance costs. Let's start today with our relevant Bible verse in the Bible reminds us in James chapter one, verse five. If any of you lack wisdom. You should ask God. Who gives generously to all without finding fault. And it'll be given to you. So let's ask the Lord for direction and insight as we explore the Roth IRA conversions today. So let's start with our first question. What exactly is a Roth IRA conversion, Ralph. Well, essentially involves transferring funds from our traditional IRA account. Into a Roth IRA account. The traditional account is something that is pre-tax money.

3:20 We call that in the trade and you're converting it to something that is an after-tax money account, or a Roth account. This transaction converts the funds from pretax, as I just said to after-tax traditional IRAs allow tax deductible contributions, and that growth is tax deferred while Roth IRAs offer tax free withdrawals in retirement. So that is really the big difference. One allows a tax deductible contribution when you make it. And then it grows. Tax-free. While the Roth offers tax free withdrawals in retirement. This conversion enables you to move some or all of your existing IRA assets into a Roth account. Now here's the kicker. You'll owe income taxes on the amount converted in the year that you convert it.

4:03 However, future qualified withdrawals then become tax-free. This could provide tremendous tax diversification and savings in retirement. Well let's talk about the benefits. So who can benefit most from a Roth conversion Ralph. The candidates to typically gain the most advantages. Are these. Those who expect to be in the same or higher income tax bracket in retirement. Converting while taxes are lower can mean. Significant savings later. It's good for young investors who have decades of tax free growth ahead. More time in the Roth provides major compounding potential. It may also be good for those who have funds in pre-tax retirement accounts, but want to leave tax-free income to their heirs Roth accounts, aren't subject to required minimum distributions.

4:48 So when you have a Roth account, you're not going to have a magic age where you need to start taking money out. It's also good for investors who experienced a temporary dip in income. Such as due to unemployment or transitioning careers. Again, this window with lower taxes can provide the ideal opportunity converting. What I'm talking about there, folks is if you have one of those years, well, let's say maybe you've lost your job or you've transitioned into a new job and you've got a dip in your income. Because you're going to take traditional IRA money and convert it to regular income. It might be a good time to do that. Roth conversion. Now here's some times when it might not be so good on the other hand. A Roth conversion and may not make as much sense if you expect your retirement income tax rate to be much lower.

5:30 Than your current rate. So what am I saying here? If you feel like your income in retirement is going to be substantially less than your tax rate in retirement could be less. Than a Roth conversion might not make a lot of sense. So you got to analyze your projected taxable income in retirement to decide if converting will pay off in the longterm. And I've had some clients do this. I've had some clients that have looked for opportunities when they have lower income and years to do this. This break, even analysis helps compare your estimated tax savings from a Roth. Versus the cost of paying taxes on the conversion today. You understand what I'm saying? Let's use a simple example. Let's say you had a $20,000 IRA account and you want to convert that to a Roth.

6:13 Well, if you convert it, that $20,000 becomes income in the year that you do it. So you might pay 20% federal tax. You might pay a state tax. So let's just use a simple example. If you lived in Delaware. Let's say this $20,000 was taxed at the 22% federal rate and then an 8% state rate. So on that $20,000 withdrawal, you're going to pay $6,000 in total tax. That means you're going to roll over only 14,000. So there's going to have to be time for that investment to recover. This leads to the question. When should you convert your traditional IRA to a Roth? Here's the short answer. The best time is when you're in a lower tax bracket than you expect in retirement.

6:54 That's really the key. For most, this means earlier in your career or during a low income year, as we talked about lower taxes mean you'll pay less on that conversion. So in our example, using that $20,000, let's say, for example, you're not working that year. Maybe you had a disability or something and your income taxes dropped into the 12% tax bracket. You could take advantage of that 10% reduction in overall income tax level to do that conversion. Here are some specific strategic times to do a conversion. A year you're unemployed or transitioning to a lower paying job. That's what we just talked about. Early in your retirement, when you have lower required minimum distributions.

7:35 During a sabbatical or other gap year with lower income. A year you have above the line tax deductions to reduce your gross income or any year taxes are decreased temporary through legislation. The technical steps to executing a raw conversion are actually quite simple. Here's what you need to do. Number one, you have to open or have an existing Roth IRA account. You'll do that with your brokerage or with your bank. Number two, you're going to contact your IRA custodian and request they transfer funds directly. And this is the key part from your traditional IRA to the Roth IRA. This is what's called a trustee to trustee transfer. You don't want to mess this up and not get this money moved over to the Roth. Number three, the custodian will issue a 1099R form documenting the gross amount converted and the taxes owed.

8:19 You're going to need to bring that to the person who handles your taxes. So that moves us on to number four. You must then pay income tax on the converted amount for the year. It was transferred. The converted funds can remain invested in the Roth account. Now here's some key pointers. You can choose to convert all or part of your traditional IRA in a given year. You want to be careful with this. If you've got a substantial IRA account, Lets say maybe you've got a couple of hundred thousand. Well I don't think you want to do all of that in one year and incur that income tax burden. Any nondeductible basis will not be taxable upon conversion. And lastly you have until April 15th of the following year to recharacterize or undo the conversion, if you change your mind. So there is an escape hatch.

9:01 If you decide to do that. They are definitely many technicalities involved with strategically executing a Roth conversion. This is where I'd recommend you sit down with a trusted financial planner or a tax professional, like myself to run the numbers for your situation. We can help you determine if converting makes sense. How much to shift over and any other implications, cause your want to consider that because you may have to set aside some taxes or actually make an estimated tax payment. The goal is maximizing tax free income in retirement while minimizing your conversion tax bill today. Now, before we wrap up, I want to remind all of our listeners to visit our podcast page. You do at askralphpodcast.com . There you can leave a review, share your thoughts, or even sending us a message with questions like we got today for future episodes.

9:46 While you're there. Make sure you join our email list. Enter into our weekly $25 Amazon gift card drawing. And I've always say, if you're not a member, you can't win. If you have specific questions about doing a Roth conversion or any other financial topic, you can also schedule a consultation with me. Right there from the website. Now I'm going to ask you to do me a favor and share this episode. If you know someone who's considering a Roth conversion or really need some financial advice we've got a great many episodes out there at our website. Over 300 episodes are out there. All of which are yours to take a look at and share them with your friends and family. So let's recap as you consider whether a Roth IRA conversion aligns with your retirement goals. Remember to seek the Lord in prayer about this significant financial move and it is a significant move.

10:31 As Proverbs chapter 16, verse three reminds us, commit your work to the Lord and your plans will be achieved. You got to ask God for wisdom and discernment regarding the pros, the cons and timing of a conversion. Let him guide your steps to make the most of what you've been given for your retirement future. I really hope this overview equipped you with a solid foundation on Roth. IRA, conversions, hope I didn't put you to sleep and how they work. If you have any other questions, please reach out. You can email me something I don't mention often. That email address is ralph@askralph.com. I'm always happy to help. You also want to remind you to check out the ask Ralph podcast website. You got mentioned that a couple times already. That's at askralphpodcast.com . You can find all kinds of great information up there.

11:14 You can find all resources are full episode, show notes, transcripts, and more. And do this for me. If you've got time, please leave us an honest review. I read each one of those. Your feedback helps the podcast reach more people with essential financial education and biblical truths. And that is our goal. In closing. Remember that God wants us to steward our finances well, so we can be a blessing to others. If you don't steward your finances. Well, you'll never be able to bless others as you make retirement plan decisions, seek his wisdom and guidance every step of the way. And as I always say, stay financially savvy, stay tuned to upcoming episodes. And may God bless you abundantly.