Converting a traditional IRA to a Roth can shield your retirement savings from future tax increases, but there are pitfalls and trapdoors, too. You’ll owe taxes on a conversion, and the up-front tax bill could be higher than you expected—particularly if the conversion pushes you into a higher tax bracket. If your income tax rate drops significantly after you retire, the tax advantages could be modest or nonexistent. And as with any financial transaction that intersects with the tax code, you—or your financial adviser—must comply with multiple rules and regulations to avoid running afoul of the IRS.
Because many people, including retirees, believe taxes will rise in the future, Roth conversions are “trendy,” says Evan Beach, a certified financial planner with Campbell Wealth Management, in Alexandria, Va. “But you see people get over enthusiastic about it, and they don’t know what they’re doing.”
Until recently, if you converted an IRA to a Roth, the law let you have a do-over. Before 2018, taxpayers who converted an IRA to a Roth had until the tax-extension deadline—typically October 15—of the year following the year they converted to change their minds. If you discovered after the fact that you couldn’t pay taxes on the conversion, you could simply put the money back into your traditional IRA and go about your business. Likewise, if the value of your IRA dropped significantly after you converted, you could undo the conversion and avoid paying taxes on phantom income.
This story is from the January 2021 edition of Kiplinger's Personal Finance.
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This story is from the January 2021 edition of Kiplinger's Personal Finance.
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