A few questions to consider when trying to decide if and how much to convert:
- Taxable Income Lower than Usual?: If you happen to be in a lower tax bracket than usual this year (or have no taxable income at all), it's a good (or great) time to think about a conversion. If you're paying very little (or even zero) tax now, then you most likely will save more tax in the future than it will cost you now.
- Investment Portfolio Hitting Lows? No one has the Magic 8 Ball to time the exact bottom of a market downturn, but in general, if your Traditional IRA or 401k has dropped dramatically in value, it will add less taxable income now to convert the now-smaller balance. The hope is that investments will rebound AFTER the conversion creating tax-free gains in the Roth.
- Can I afford to pay the taxes now? If you do convert, make sure you can afford to pay the resulting tax out of pocket. If you need to use the pre-tax funds to pay the tax on conversion, that tax withholding will count as an early distribution (if you're currently under 59 1/2) and cost you tax AND an added 10% penalty for early withdrawal. Let us help you calculate the cash you'll need for taxes before you make a large conversion!
- How much do I already have in each basket? We think it's a great idea to have some money in both Roth and pre-tax retirement. There's always a certain amount you can earn each year without owing taxes, so converting every dollar to Roth and having zero taxable income from age 65 or 70+ is not optimal planning (it means you could have paid less taxes while working and possibly retired earlier!). Discussing an overall plan with a financial planner is highly suggested. Maybe you don't need to convert anything and just want to reallocate current/future savings to reach your goals for each basket.
Schedule a Consult with your Tax Preparer now to discuss your specific situation further.* We'll want to begin by doing a tax projection for the current year, so you can also start by sending your tax accountant recent paystubs and/or business income/expenses along with a listing of current balances in all of your different types of retirement accounts. With that, they can give you a good idea of what your tax bill would be for converting some or all of certain retirement funds to Roth.
Hope you're having a great summer!
Mark, Alyssa and the Fox Tax Team
*Standard Consulting Rates of $80/hour will apply for this type of service.
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