When you first set up an individual retirement account, you’ll be faced with a number of different choices to make, long before you ever have to be concerned with whether you should convert to Roth. First you’ll need to decide whether to open your new account with a traditional IRA custodian, or a self-directed IRA custodian such as Quest Trust Company. Choosing a self-directed IRA will give you the greatest investment flexibility.
You’ll also need to decide on the type of account – a traditional IRA form or a Roth IRA. While many of the basics features for each account are similar, there are some important differences between the two. Traditional IRAs have the advantage that contributions are sometimes tax deductible in the year they’re made. On the other hand, withdrawals from Roth IRAs are completely tax free (unlike traditional IRAs), and Roth accounts are not subject to the rules on required minimum distributions. For many retirement savers, a Roth IRA is a better long term solution to their needs.
Unfortunately, some people only come to this conclusion after they’ve already opened and grown one or more traditional IRAs. Fortunately, it’s possible to convert to Roth from a traditional IRA. The process is very straightforward, although the account owner will be responsible for paying a current year tax (based on their income tax rate) on the amount of the conversion.
Here are some Roth conversion 2021 tips for deciding whether or not this is the year you convert your to Roth from your traditional IRA.
How do your current tax rates compare to your expected future rates? Generally speaking, if you anticipate that your tax rates during retirement will be higher than your current tax rates, then a Roth account is preferable, and perhaps you should convert to Roth. Paying taxes now at a lower rate to avoid paying taxes later at a higher rate (and, in fact, to avoid paying taxes at all on withdrawals from a Roth IRA) can save you significant amounts of money.
Are the rules on required minimum distributions likely to affect you? Be sure to take into account the effect that required minimum distributions (“RMDs”) may have on your overall retirement plan. The IRS rules on RMDs state that an owner of a traditional IRA must begin taking certain minimum withdrawals from their account once they reach age 72. If you have other sources of retirement income besides your IRA, and would prefer to let the money in your IRA continue to grow on a tax-preferred basis, then you may want to convert to Roth.
What’s Your Expected Rate of Return? Finally, your investment returns on your IRA may influence your decision. If your expected rate of return is high, then the value of having a Roth IRA and never having to pay taxes on investment earnings can be significant.
Deciding whether it’s appropriate to convert to Roth from your traditional IRA should be done every year. For example, if your income varies significantly from year to year, then you may want to target a relatively low-income year as one in which a conversion may be appropriate.
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