Individual retirement accounts (IRAs) and 401(k)s serve an important purpose in estate planning, helping individuals begin saving during their prime earning years to provide a financially secure retirement in the future. Contributions to these plans today reduce your taxable income in the year of contribution and grow tax-deferred until you take distributions in retirement. However, with tax rates currently at historic lows and the prospect of higher taxes in 2026, now may be the ideal time to consider converting all or a portion of these plans into Roth IRAs or Roth 401(k)s.
Unlike traditional retirement savings plans, Roth plans require you to pay taxes on your contributions upfront in return for tax-free growth and distributions in retirement. Participation in these plans is restricted based on a taxpayer’s modified adjusted gross income (MAGI). For example, contributions to a Roth IRA in 2024 are limited to individual taxpayers with a MAGI of less than $146,000 (or $230,000 for married filing jointly.) Consequently, Roth IRAs and Roth 401(k)s are commonly used by young investors in lower income-tax brackets who are just starting to earn wages. However, older and wealthy investors can also reap the rewards of tax-free distributions in retirement through a Roth conversion or back-door Roth.
Converting a traditional IRA or 401(k) to a Roth IRA or Roth 401(k) is a relatively simple process, but it is a taxable event. At the time of the conversion, you will need to pay taxes on your original contributions and investment gains. While these tax liabilities may be substantial, they may be less than you would pay on distributions from a traditional IRA or 401(k) taken later in life when the capital gains rate could be nearly double what it is today.
Another option for high-net-worth-investors to receive all the tax benefits of a Roth IRA while avoiding the income limitations is to open and fund a traditional IRA and quickly convert it to a Roth. For example, if you opened a traditional IRA with $6,500 in 2023 and converted it to a Roth IRA in 2024, you will be required to pay taxes on your $6,500 contribution and any earnings gained over the past year, which should not be too significant. However, the IRS will treat the converted amount as income, which may put you into a higher tax bracket.
The good news is that you can plan for the tax liabilities that come with backdoor Roths and Roth conversions. Meet with experienced financial advisors who can not only provide you with estimates of your potential tax obligations and savings, but also help to ensure that a conversion fits within your larger estate planning needs and goals.
About the Author: Lee F. Hediger is a co-founding director with Provenance Wealth Advisors (PWA), an Independent Registered Investment Advisor affiliated with Berkowitz Pollack Brant Advisors + CPAs and a registered representative with PWA Securities, LLC. He can be reached at the firm’s Fort Lauderdale, Fla., office at (954) 712-8888 or info@provwealth.com.
Provenance Wealth Advisors (PWA), 200 E. Las Olas Blvd., 19th Floor, Ft. Lauderdale, FL 33301 (954) 712-8888.
Lee F. Hediger is a registered representative of and offers securities through PWA Securities, LLC, Member FINRA/SIPC.
This material is being provided for information purposes only and is not a complete description or a recommendation. The information has been obtained from sources considered to be reliable, but we do not guarantee that the preceding material is accurate or complete. There is no guarantee that these statements, opinions or forecasts provided herein will prove to be correct.
Any opinions are those of the advisors of PWA and not necessarily those of PWA Securities, LLC. While we are familiar with the tax provisions of the issues presented herein, as Financial Advisors of PWAS, we are not qualified to render advice on tax or legal matters. You should discuss any tax or legal matters with the appropriate professional. Prior to making any investment decision, please consult with your financial advisor about your individual situation.
Roth IRA owners must be 59½ or older and have held the IRA for five years before tax-free withdrawals are permitted. Additionally, each converted amount may be subject to its own five-year holding period. Converting a traditional IRA into a Roth IRA has tax implications. Investors should consult a tax advisor before deciding to do a conversion. Changes in tax laws may occur at any time and could have a substantial impact on each person’s situation. While we are familiar with the tax provisions presented herein, as financial advisors of PWA Securities, LLC, we are not qualified to render advice on tax or legal matters. You should discuss tax or legal matters with the appropriate professional.
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Posted on August 15, 2024