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Looking to Convert a Traditional IRA to a Roth IRA? Top Considerations to Know:

You’ve worked hard to plan, save, and invest for your retirement. That’s why we are passionate about educating our clients about their options when saving into retirement accounts. When markets start to dip, a lot of clients have questions about what type of IRA is ideal for them and whether converting a Traditional IRA to a Roth IRA makes sense. While the answers vary depending on each person’s circumstances, market downturns can be a good time to look at all of these areas to see if there are opportunities to explore.

Most people begin saving for retirement using Individual Retirement Accounts (IRAs) unless they are contributing to an employer-sponsored retirement savings plan like a 401(k). You have two main options when it comes to saving into an IRA: the Traditional IRA and the Roth IRA. Each has its own distinctive characteristics and benefits. And, as IRA account holders’ circumstances change, it may make sense to consider converting a Traditional IRA to a Roth IRA. 

What is a Traditional IRA?

A traditional IRA is an account that allows an individual to save and invest money with the expectation that their funds will grow tax deferred for their retirement. Anyone can contribute to a Traditional IRA if they have earned income. However, the level to which the contribution is tax-deductible is dependent on income levels and household employer retirement plan participation. No taxes are paid on Traditional IRAs until the IRA owner begins to withdraw funds from the account, typically after age 59.5. These withdrawals, or distributions, can be used as retirement income –but taxes will be due on all or a portion of the withdrawal, depending on whether the original contributions were tax deductible. 

What is a Roth IRA?

A Roth IRA is similar to a Traditional IRA in that it’s an account designed for individuals to save and invest for retirement. However, a Roth IRA only allows you to contribute after-tax dollars and contributions can be made only if you are under certain income thresholds. The big difference for a Roth IRA holder is that the money you contribute, and any growth in the Roth IRA is tax-free, even when you withdraw funds after age 59.5. 

When Should You Use a Traditional vs. a Roth? 

This is the age-old question for so many professionals. You want to save your hard-earned income to support your retirement, but knowing when and how are the big questions to answer as tax implications and time are your two biggest variables. It is best to consider your income levels, current and future tax brackets, and your age, or when you plan on withdrawing from the IRA. These factors are unique for each person and may change based on career trajectory, health, or other variables in life. 

Should You Convert Your Traditional IRA to a Roth IRA?

In a down market, many investors consider converting from a Traditional IRA to a Roth IRA. When a conversion is made, the Traditional IRA account holder has to pay taxes on the amount converted. But during a down market, the asset valuations may be lower compared to future growth expectations. The thought is that when the market recovers, the valuation will improve, helping recoup any of the hit you may have felt by paying taxes on the amount converted. The big question is if you will make up the taxes paid before you need to start to withdraw funds? This decision is complex because each person’s situation is unique with factors in play around age, income level, income growth opportunities, retirement timeline, and expectations about future tax rates. At Planning Alternatives, we help clients evaluate if a Roth conversion could be an attractive opportunity and how it may fit into their financial plan.

Talk About Taxes

When it comes to IRAs, your financial advisor should be in close communication with your CPA due to the interplay between your taxes and your retirement income plans. At Planning Alternatives, we work closely with your CPA to ensure everyone on your team is on the same page for your benefit. It’s a collaborative relationship and one we take very seriously as any investment decision should take into account all relevant information, especially when it comes to planning for your retirement.

Traditional or Roth? There’s not always a cut and dry answer. It’s always an individualized choice based on your unique situation and personal goals. We know it can often feel confusing. We’re not only fiduciaries, doing what’s in your best interest, but we’re here to break it down for you. We’re here to explain the why behind our recommendations so you can feel confident in your investment decisions. 

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