3 Strategies for Reducing Roth Conversion Taxes

August 12, 2024 Rob Williams

How to make the most of a Roth IRA conversion.

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A Roth IRA conversion may be right for you if you have a year where either your taxable income is lower than normal or your income is too high to contribute to a Roth IRA outright ($161,000 and up for individuals or $240,000 and up for married couples filing jointly in 2024). With a Roth conversion strategy, you convert all or part of your traditional IRA to a Roth IRA and pay regular income taxes on the converted amount.

Why convert to a Roth IRA?

It may seem counterintuitive to pay taxes now instead of later when you start taking required minimum distributions (RMDs), but doing so will allow you to take advantage of a Roth IRA's main features: tax-free withdrawals of contributions and earnings in retirement—so long as you're 59½ or older and have held the account for at least five years. (If you're younger than 59½, you can withdraw Roth IRA contributions anytime tax- and penalty-free, but you may pay taxes and penalties on earnings depending on how long you've held the account and how you're using the money.)

A Roth IRA is an attractive option for individuals who believe their tax rate may be higher in retirement, or for those who just want the flexibility that tax-free income provides. And, unlike tax-deferred retirement accounts, Roth IRAs aren't subject to RMDs beginning at age 73.

Tax-smart strategies for a Roth IRA conversion

If you think a Roth IRA conversion might be right for you, here are three tax-efficient strategies to consider:

Max out your bracket: Let's say you're single and make $150,000 a year, which puts you in the 24% tax bracket. The next bracket doesn't kick in until your income exceeds $191,950, so you could convert up to $41,950 ($191,950 – $150,000) and still stay within your current bracket.
Spread it out: Breaking up the conversion across multiple years can make the tax hit easier to manage—and could, when combined with the strategy above, reduce the overall tax you pay on the conversion.
Get ahead of tax changes: If upcoming changes to tax law will adversely affect future taxes, converting some or all your traditional IRA in the year preceding the change could help you avoid paying more tax on the conversion than necessary.

Bottom line

In any case, you may want to wait until the end of the year to perform a Roth IRA conversion to account for any and all changes to your total taxable income. Or work with a tax professional who can help project your total taxable income for the year and create a plan to max out your tax bracket with conversions and potentially minimize your tax obligations—annually and over time.

The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. The investment strategies mentioned here may not be suitable for everyone. Each investor needs to review an investment strategy for his or her own particular situation before making any investment decision.

All expressions of opinion are subject to change without notice in reaction to shifting market conditions. Data contained herein from third-party providers is obtained from what are considered reliable sources. However, its accuracy, completeness, or reliability cannot be guaranteed.

Examples provided are for illustrative purposes only and not intended to be reflective of results you can expect to achieve.

Investing involves risk, including loss of principal.

The information and content provided herein is general in nature and is for informational purposes only. It is not intended, and should not be construed, as a specific recommendation, individualized tax, legal, or investment advice. Tax laws are subject to change, either prospectively or retroactively. Where specific advice is necessary or appropriate, individuals should contact their own professional tax and investment advisors or other professionals (CPA, Financial Planner, Investment Manager) to help answer questions about specific situations or needs prior to taking any action based upon this information.

Roth IRA conversions require a 5-year holding period before earnings can be withdrawn tax free and subsequent conversions will require their own 5-year holding period. In addition, earnings distributions prior to age 59½ are subject to an early withdrawal penalty.

Tax-free withdrawals of earnings are permitted five years after creating an account with the first contribution. Once the five-year requirement is met, distributions will be free from federal income taxes if taken: (1) after age 59½; (2) on account of disability or death; (3) to pay up to $10,000 of the expenses of purchasing a first home; or (4) to cover birth or adoption expenses of up to $5,000. Withdrawals that do not meet these qualifications will generally be subject to ordinary income taxes and a 10% federal tax penalty. However, certain distributions are not subject to the 10% federal tax penalty, but are subject to ordinary income taxes over one or more years, although such tax may be refunded if the distribution is repaid within three years: (1) a distribution of up to $22,000 due to a qualified federally declared disaster; (2) the lesser of $10,000 or 50% of the vested account balance to a domestic abuse victim; and (3) one emergency expense distribution per year up to the lesser of $1000 or the vested account balance minus $1000.

The Schwab Center for Financial Research is a division of Charles Schwab & Co., Inc.

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