To contribute to a Roth IRA in 2023, single tax filers must have a modified adjusted gross income (MAGI) of $153,000 or less, up from $144,000 in 2022. If you make $138,000 or less, you can contribute the full maximum to a Roth IRA.
However, if married and filing jointly, your joint MAGI must be under $228,000 in 2023 (up from $214,000 in 2022). If married couple makes $218,000 or less, they can contribute the full maximum to a Roth IRA.
For those who have a traditional IRA and are now making over $153,000/$2228,000, you can currently do a backdoor Roth IRA conversion. You pay taxes upfront so you don’t have to pay taxes upon withdrawal.
As a reminder, you can contribute a maximum of $6,500 to a traditional IRA tax-free in 2023. You can deduct the contribution from your current income, which lowers your current federal tax bill. Upon withdrawal, you must pay taxes based on a future unknown income tax rate.
For a Roth IRA, you contribute after-tax money. The money and all future gains are tax-free upon withdrawal. This article discusses why a Roth IRA conversion is probably a waste of time and money for most people.
Why You May Still Not Want To Do A Roth IRA Conversion
When deciding on a Roth IRA conversion the key variable to solve for is your tax rate. If your tax rate is the same when you are contributing to a traditional IRA and when you retire, there is no saving.
Below are the latest federal income tax brackets and rates for single filers, married couples, and heads of households.
Let’s say you are 40 years old and make $65,000 a year. This income level puts you in the 22% marginal federal income tax bracket.
If you invest $6,000 in a traditional IRA and it grows at 8% a year for 20 years, you will end up with $27,965. When you withdraw the money, you decide to withdraw all of it and pay the same 22% marginal federal income tax. Therefore, you end up with $21,813.
On the other hand, if you contribute to a Roth IRA, you have to pay 22% tax on that $6,000 upfront, leaving you with $4,680. If it grows at 8% a year for 20 years, at age 60 you can withdraw, tax-free $21,813. In other words, the results are the same.
If the tax rate is the same, here is the equation that proves contributing to a traditional or Roth IRA is a wash.
Y = A * B. Re-arrange to A = Y / B. Or Y = A * B is equal to Y = B * A.
Forecasting Future Tax Rates Is Key For Roth IRA Contribution
Some may argue that tax rates must go up in the future to pay for all our deficit-spending today. However, when I first wrote the classic post, Disadvantages Of A Roth IRA: Not All Is What It Seems, eight years ago, people were arguing the same thing. Then Donald Trump came into office and lowered tax rates under the Tax Cuts And Jobs Act.
Therefore, nobody can be sure what tax rates will be in the future. But what we should feel confident about is NOT seeing tax rates go higher for the middle class. Politicians will always depend on the middle class to stay in power. Therefore, politicians will unlikely hurt the middle class through higher taxes.
There are many ways to define the middle class. Given we are talking about income tax rates to determine a Roth IRA conversion, one commonly acceptable middle-class definition is the median household income up to + 50%.
The Middle Class Will Unlikely Be Paying Higher Taxes In Retirement
The current median household income is about $75,000. Therefore, the middle-class definition for the country is income up to about $112,500.
Given politicians also have to account for millions of people living in higher cost of living areas as well, a middle-class income can also be adjusted higher.
For example, a family of four in San Francisco is considered “low income” if it earns $117,000 or less. Therefore, in my opinion, a middle-class definition may be considered earning up to $300,000 in the SF Bay Area.
In other words, it is highly unlikely tax rates for those earning up to $300,000 inflation-adjusted, will ever be raised. In fact, President Biden has stated he will not raise taxes for anyone earning less than $400,000. Therefore, $300,000 seems to be a conservative income cut-off point for facing future tax increases.
That said, please be aware the tax cuts implemented by the Tax Cut and Jobs Act will expire on December 31, 2025. Therefore, for those of you in the lower marginal tax bracket, shifting some assets to a tax-now Roth IRA can make sense.
Your Income Will Likely Be Lower In Retirement Than While Working
We’ve made the argument that household income up to $300,000 will likely not face tax hikes. Now let’s argue why our incomes will likely be lower in retirement. Lower incomes in retirement also correlate with lower tax rates.
On the face of it, arguing your income will likely be lower in retirement than while working makes sense. After all, by definition, you’re not working in retirement! Most of your income will come from Social Security, a pension if you’re lucky, and investments.
Of course, the modern-day retiree often works on side hustles that keep them busy. Therefore, there could certainly be some extra active income coming in.
But for the most part, most retirees will just live off what they’ve saved and what the government and maybe their company have promised them. In a low interest rate environment, generating more investment income is more difficult.
Retiree Example #1: The Luckiest Ones
Let’s say you’re lucky enough to amass $1 million in your IRA at age 67. I write “lucky” because only ~12% of Americans have $1 million or more saved for retirement, according to a 2020 TD Ameritrade Survey. Who knows the exact percentage, but we can be certain that only a small minority have seven-figure retirement accounts. That said, I firmly believe the majority of FS readers will be millionaires in retirement.
At age 67, you’re also eligible to collect the maximum Social Security benefit of $3,011. This amount comes out to $36,132 a year and will go up with inflation. Yet another lucky break, even though you contributed to the system for many years.
How much should you withdraw from your traditional IRA to fund your retirement lifestyle? You plan to live a comfortable lifestyle until age 90. Therefore, you decide that withdrawing at a 4% rate sounds good. You can always adjust the withdrawal rate in the future.
Your total income is now $76,132, $36,132 from Social Security + $40,000 from your traditional IRA. A $76,132 income squarely puts you in the middle class, the Safe Zone where income taxes won’t go up!
Not All Your Income Is Taxable
However, $76,132 isn’t your taxable income. Let’s say the standard deduction of $12,550 per individual and $25,100 per married couple, inflation-adjusted, still exists when you are retired. If so, your maximum taxable income is $63,582.
Further, did you know that your Social Security income isn’t fully taxed? The portion of your Social Security benefits subject to taxation varies with income level. You’ll be taxed on:
- up to 50 percent of your benefits if your income is $25,000 to $34,000 for an individual or $32,000 to $44,000 for a married couple filing jointly.
- up to 85 percent of your benefits if your income is more than $34,000 (individual) or $44,000 (couple).
In other words, even if you are one of the lucky retirees with a $1 million traditional IRA and who can collect the maximum Social Security benefit, your tax rate still likely won’t go up. In fact, it may actually decrease.
For the vast majority with lower incomes, they almost certainly won’t be facing a higher income tax bracket in retirement.
Retiree Example #2: The Lottery Winner
Roth IRAs are most valuable for those with top 1% net worths and top 1% incomes IN retirement. Roth IRAs are also a valuable tool for tax planning for those dealing with a big estate, because the heirs can draw the money tax-free.
The issue is, how many of us will retire in the top 1%? Only 1% or less.
Let’s say you’re a lucky individual making $700,000 a year. You’re in the top marginal federal income tax bracket and are concerned about paying a 39.6% marginal federal income tax rate in retirement versus 37% currently.
Therefore, you decide to do a Roth IRA conversion and pay a 37% rate upfront on the pre-tax contributions you made when you were only in the 22% marginal income tax bracket years ago.
Yikes! This Roth IRA conversion locks in a 15% loss with the potential for only saving 2.6% in federal income taxes in the future.
Top 1% Net Worth Composition Breakdown
After 20 more years of making at least $700,000 a year, you amass a fortune of $15 million. Out of the $15 million, $5 million is in a Roth IRA conversion, $5 million is in after-tax brokerage accounts, $3 million is in your primary residence, and $2 million is in rental properties.
Hooray for having a top 1% net worth, which currently has a minimum net worth cut off of $10 million.
You could only have achieved this net worth by consistently saving 50% of your after-tax earnings and investing the difference. Only a minority of people have such a high saving rate. Therefore, you were really “only” living off about $200,000 a year.
In retirement, your $5 million in after-tax brokerage accounts is generating $100,000 a year in dividends. While your $2 million in rental properties is generating about $80,000 a year in taxable income. Your total investment income is about $180,000 a year.
Raising Spending From $200,000 to $300,000
Given life is short, you decide to target ~$300,000 a year in gross spending, or 50% more than during your 20 years of work. Therefore, you decide to withdraw $120,000 a year, or 2.4% from your Roth IRA each year. Your total income is closer to $336,000 thanks to also being eligible for Social Security.
For tax simplicity’s sake, your $336,000 in total retirement income faces a maximum marginal federal income tax rate of 35%, which is still lower than the 39.6% when you did the Roth IRA conversion.
You would need to withdraw closer to $200,000 from your Roth IRA to potentially start paying the same marginal federal income tax rate. But can you really comfortably spend double what you’ve been used to spending for the past 20 years? Doubtful.
Again, to get to a $336,000 annual retirement income requires you to get to a $15 million net worth. Not possible for more than 99% of the population. Please be realistic with your expectations.
For a quick calculation, take whatever you are making now and divide it by 3% and 4%. The result is your likely liquid net worth target necessary to be able to generate a similar level of income in retirement. If you have a similar level of income in retirement, your tax bill likely won’t increase.
Making Up For My Lack Of Roth IRA Contribution
Despite highlighting how doing a Roth IRA conversion likely won’t save you money, I still regret not contributing to a Roth IRA when I was in school and during my first year of work. But I can’t be blamed too badly for my lack of contribution because it only became a savings option to the public in 1998, when I was a junior at William & Mary.
The last thing I was thinking about junior year was saving for retirement. All I wanted was to get a job and prove that going to college was worth it. By the time I understood the merits of contributing to a Roth IRA, my income had surpassed the income limit to be able to contribute.
Therefore, I’m making up for my mistake by contributing to a custodial Roth IRA for my kids. Thanks to the standard deduction and their low wage, they’ll essentially get to earn tax-free money to be able to contribute to a Roth IRA. I recommend doing the same for your low-income earning kids.
Contribute to a Roth IRA when you can. Even if you just have $20,000 in a Roth IRA, it will grow to over $200,000 in 30 years if it compounds at 8%. If you can invest in a moonshot that becomes the next Facebook, then it’s obviously worth investing your Roth IRA money if you can.
Still Not Doing A Roth IRA Conversion Today
But in terms of doing a Roth IRA conversion now, I still can’t succumb. It feels like one last trap the government is setting to get Americans to fork over even more money. Further, my tax bracket is too high.
All of us have the ability to adjust our income, and therefore, our tax rates in retirement by:
- Moving to a more tax-efficient state
- Rebalancing our portfolios to non-dividend-paying investments
- Donating more of our wealth to charity while living
- Gifting more of our wealth to our children and other individuals
- Investing in new non-income producing investments
- Starting a business
- Withdrawing at different rates
As soon as you do a Roth IRA conversion, it’s like surrendering to the government. Sure, you’ll get the tax-free benefits upon withdrawal. But even that is not a certainty. The government could always pass new legislation.
The irony about eliminating the Roth IRA conversion is that Congress might actually save thousands of Americans lots of tax dollars. The headlines about how one man was able to earn a 100,000X return on his Roth IRA is unlikely going to happen for most Americans.
If you must do a Roth IRA conversion, make sure you run various scenarios. The “worst” case scenario is if you end up making more in retirement than while working. If so feel extremely blessed! Paying more in taxes because you failed to do a conversion isn’t that big of a deal.
Psychologically, you can think about paying more taxes than you could have as a contribution to society. This goes for both a traditional and Roth IRA. Just don’t think about all the waste and corruption.
The Best Time To Do A Roth IRA Conversion
In retrospect, the best time to do a Roth IRA conversion for me was in 2013. 2013 was my lowest income year because it was the first full year I didn’t have a job. I stopped receiving a steady paycheck by June 2012.
Unfortunately or fortunately, even unemployed, I was still in the 28% marginal federal income tax bracket ($87K-183K for individuals) at the time because tax rates were higher then. Further, I was earning passive investment income, some online income, and had deferred investment income as part of my severance package coming in for the next four years.
Paying six-figures in taxes to do a Roth IRA conversion wasn’t enticing when my income was still way down. Therefore, I decided to just roll over my 401k into a traditional IRA. Psychologically, you will probably also feel like holding onto as much wealth as possible if you lose your job.
Therefore, the best time to do a Roth IRA conversion is when you are unemployed with little-to-no other income sources and there’s a bear market. At a 0%, 10%, or even 12% marginal income tax bracket, you should probably find the time to convert. There may not have a better opportunity in the future.
For most people, the best time to do a Roth conversion is after you retire, are in a lower tax bracket, but before claiming Social Security benefits.
Further, Roth IRAs aren’t subject to Required Minimum Distributions at age 72, unlike traditional IRAs and 401(k)s. This comes in handy if you want to pass on your Roth IRA to someone else.
Related: Rolling Over Leftover 529 Funds Into A Roth IRA
Making The Right Choice In Terms Of Probabilities
Here are my estimated probabilities for a positive outcome if you do a Roth IRA conversion at your current marginal federal income tax bracket. A positive outcome is defined as saving money on taxes.
- 10% tax bracket: 95% chance contributing or converting to a Roth IRA is the right choice
- 12% tax bracket: 90% chance contributing or converting to a Roth IRA is the right choice
- 22% tax bracket: 70% chance contributing or converting to a Roth IRA is the right choice
- 24% tax bracket: 60% chance contributing or converting to a Roth IRA is the right choice
- 32% tax bracket: 40% chance contributing or converting to a Roth IRA is the right choice
- 35% tax bracket: 30% chance contributing or converting to a Roth IRA is the right choice
- 37% tax bracket: 20% chance contributing or converting to a Roth IRA is the right choice
- 39.6% tax bracket: 10% chance contributing or converting to a Roth IRA is the right choice
If you make less than $125,000 as an individual or less than $198,000 as a married couple, you can contribute the maximum $6,000 to a Roth IRA. Paying a 24% marginal federal income tax rate is reasonable. You’ll likely come out ahead with a more diversified retirement income source.
But for those of you in the 32%, 35%, or 37% tax bracket, a Roth IRA conversion is likely going to end up costing you more tax dollars. The break-even tax rate is somewhere around 26% – 28% where converting or not won’t make a big difference.
Diversifying retirement income sources is great. However, always run different scenarios in this uncertain world. There’s a good chance what you think will happen will never happen.
Roth IRA Conversion Recap
- Forecasting your retirement tax rate is the key variable
- Tax rates are unlikely to go up for the middle class (up to ~$300K income)
- You will likely make less in retirement than while working
- Contribute to a Roth IRA when you can
- For your highly speculative investments, make them in a Roth IRA if possible
- You have more ways to lower your taxable income in retirement than you think
- If you find yourself unemployed or underemployed, consider a Roth IRA conversion, even thought it will feel painful
- Even if you end up paying more in taxes in retirement, feel grateful you did so well
- So long as you are maxing out a a tax-advantaged retirement account that is the most important thing
Manage Your Money Wisely
Stay on top of your finances by signing up with Empower Personal Capital or NewRetirement. PC is a free online tool I’ve used since 2012 to help build wealth. NewRetirement has more granular retirement planning tools.
Before Personal Capital and NewRetirement, I had to log into eight different systems to track 35 different accounts. Now I can just log into Personal Capital or NewRetirement to see how my stock accounts are doing. I can easily track my net worth and spending as well.
Related posts:
How Much You Should Have Saved In Your 401k By Age
Recommended 529 Plan Amounts By Age: A Roth IRA Alternative
Use A 529 Plan For Generational Wealth Transfer Purposes
Readers, are you looking to do a Roth IRA conversion before Congress changes the laws? If so, what are your reasons for doing so? I’d love to hear more arguments for why a Roth IRA conversion isn’t a waste of time and money.
For more nuanced personal finance content, join 55,000+ others and sign up for my free weekly newsletter. You can also sign up for my posts and receive them via e-mail every time I publish. I’ve been writing about Roth IRA conversion and other financial topics since 2009.
Hi, Just listened to this podcast episode (& scanned through many of the Comments)…what appears to be missing is Roth Conversion in “gap years” between ending employment (& entering lower/middle tax bracket from higher tax bracket during full-time employment) & RMD’s @ age 72 that will force income back into higher tax brackets.
Excellent point, which I need to include in this post. I had that down year when I left my job in 2012 and I didn’t do a conversion. But 2012 wouldn’t have been a good year because I got a large severance check. So maybe 2013. But then maybe 2013 wouldn’t have been a good year because my income started to rise and I didn’t wanna pay a lot of taxes upfront when I had no steady day job income.
So it can be tricky! The last thing you want to do when you don’t have a steady day job is to pay more taxes upfront. It’s hard to part with that money. Psychological.
Hey there FS. Just finished your book, well done. I don’t understand the concept of a company giving a huge severance package to an exiting employee. Granted I don’t work in the ivory office towers of big business or the finance world but riddle me this (because I really do want to understand).
Example A – a company in downsizing and letting people go. Clean break. Your last day is X and thank you for your service. Company no longer has the payroll/bonus obligation toward that employee.
Example B – The employee is planning on quitting on their own accord and as such will no longer provide income producing work for the company. Resignation accepted. Company no longer has an payroll/bonus obligation toward that employee.
Why would a company in either situation afford either employee the opportunity to negotiate a multi year package of pay when in either case the company will no longer have the ability to generate revenue from that employee ???
It’s a great victory, I just simply don’t understand. Thanks. Really enjoy your content.
I’m glad you enjoyed the book! Your thinking is totally understandable. Most people cannot conceive of why a company would offer a severance package.
The key is understanding the other Sides needs. If you give your two week notice, you leave your manager and your employees in a lurch. Further, if a manager is tasked with letting employees go, it is one of the hardest things any person can do.
So by thinking about how you can provide a seamless transition so that your manager doesn’t have to spend 3 to 6 months hiring your replacement and then training your replacement for several months to get up to par, or saving your manager the heartache of letting someone go, you learn how to create a win-win scenario in exchange for a severance package.
Here are some relevant posts for you to consider.
https://www.financialsamurai.com/quitting-your-job-is-selfish-engineering-your-layoff-is-the-ethical-way-to-go/
https://www.financialsamurai.com/how-to-negotiate-a-severance-as-an-excellent-employee/
https://www.financialsamurai.com/why-negotiating-a-severance-is-possible-absolute-reputational-destruction/
I also wrote a book about how to negotiate a severance if you’re interested. It is in its fifth edition and the overwhelming feedback from readers has been positive. Most cannot believe what they were able to get.
Finally, if you don’t mind leaving a great review on Amazon for Buy This, Not That, I would appreciate it! It is the best gift for an author who did their best to add value.
Regards,
Sam
Sam, I think you left out an important scenario. For those of us with employment-based pre-tax 401K and already maxing it out, any traditional IRA contribution is after tax anyway. I still do the after tax contribution and immediately convert to a Roth. That way I am paying the tax I need to pay anyway now, but get the tax free treatment on gains at withdraw. I think the same argument goes for after tax account and Roth 401K (the mega-both) route, with the assumption of maxing out pre-tax 401K first. Do you agree or am I missing something?
I think that’s the point, whether a conversion should be done anyway or not. It depends on how wealthy do you think you’ll be in retirement and what the tax rate will be.
I don’t know you’re specifics, so I can’t tell you. But I think the logic in this post is sound. More people will make more money while working than while retired.
I think Karen is raising an important point that is not addressed or clarified by this article. The main argument above is whether to convert from a traditional IRA to a Roth IRA, the decision of which is centered around a person’s marginal tax rate now versus when in retirement.
However, if that person is eligible to contribute to a workplace retirement plan like a 401K and earns income over the max allowed ($78K in 2022), then they cannot deduct any of their traditional IRA contributions, the above arguments in the article are moot.
In this scenario, the decision then becomes whether to contribute after-tax dollars to a traditional IRA or convert it to a Roth IRA: there is no difference on how contributions are taxed up front. However, with the contributions converted to a Roth IRA, the gains will be tax free, and there are no RMDs compared to a traditional IRA. In this scenario then, it seems like the best decision is to do the conversion. The real question – again in this scenario only – is whether to put this money into an IRA/Roth IRA to start with, for these reduced benefits. Some would say yes because you’re still getting tax-free gains, and you’re forcing yourself to save into a retirement vehicle. But others think the tax-free savings on the gains aren’t worth restricting one’s investing of $6K a year.
Good point and true. Thanks
I think you are ignoring the RMD schedule for traditional IRAs. You are not free to take out as much as you want each year. If you have $5M in your IRA you need to take out over $500K when in your 90s.
themoneyalert.com/rmd-tables/
In context of people who would like to retire earlier than 67, the RMD concern at 72 (and potentially moving to 75) is not a big one. Only people with very large balances will face RMDs larger than they want to take. And they enjoyed the tax deferral for a very long time – pay up already.
In the early 60s, Roth money can be very useful for keeping your taxable income in the first two tax brackets, making LTCGs and dividends tax free. Married couples stay in this up to 106k. Supplement with 50k in Roth and that lets you spend closer to 160k per year, while letting the traditional IRAs build.
This is also a potential incentive to take Social Security early. Even if you live beyond the break even point in the early 80s, your IRA can be expected to gain more than the value of your higher SS benefits that may or may not exist in your 90s.
The other potential benefit to call comes even if tax rates stay unchanged.
I just want to add that the other best time to do a Roth IRA conversion is when the market crashes. I’ve had a few opportunities including March 2020 but when the market is crashing, I’m usually too distracted to think about Roth IRA conversions.
I had bigger fish to fry. In this last round, I was focused on accumulating a cash reserve for all the lost rents from the eviction moratoriums.
For sure, when the market crashes or when you lose your job. The mass layoffs are coming. It’s just hard to pay taxes upfront after losing your job and money in your investments.
I posted previously with some tax errors. But I wanted to post again with some hypothetical numbers.
Our household is in the 24% tax bracket. We have substantial pensions that will provide around 140,000 yearly starting in 4 years. We are 51. The decision maker and I will both have topped out social security. We have 10 year old children. Our planning revolves around their futures.
House will be paid for in less than 4 years and we have low 7 figures in tax sheltered accounts. 25% is in ROTH accounts now. We are doing 80,000 ROTH conversions yearly for at least the next 5 years.
It is easier to make these conversions during our earning years because it is ingrained in our lifestyle. End result is an easy transition to our kids and tax free growth.
ROTH conversions are simple. It will
Make retirement less complicated with most of our investments in ROTH.
Conversions look most advantageous anywhere from teens to mid 60s. Personally, We have been doing them since age 48.
INTERESTING NUMBERS
Rate of return of 10% over 40 years. $19,500 invested every year. Age 22-62. Payroll, conversion, Pretax comparison.
End account value $8,630,554 on ROTH accounts.
PAYROLL
22%: 19500/.78 = 25,000. 5500 (40) = 220,000 total cost.
24%: 19500/.76 = 25,567. 6157 (40) = 246,280 total cost.
32%: 19500/.68 = 28,676. 9176 (40) = 367,040 total cost.
CONVERSION
22%: 19,500 x .22 = 4290 (40) = 171,600 total cost.
24%: 19,500 x .24 = 4680 (40) = 187,200 total cost.
32%: 19,500 x .32 = 6240 (40) = 249,600 total cost.
Buying power is 8,630,554 across all examples in ROTH.
PRETAX
12%: 8,630,554 x .12 = 1,035,660 lien.
12% buying power = 7,594,894
22%: 8,630,554 x .22 = 1,898,721 lien
22% buying power 6,731,833
24%: 8,630,554 x .24 = 2,071,332 lien
24% buying power 6,559,222
Heirs have to draw down the entire 8,630,554 in 10 years and pay tax on all withdrawals.
Comparing to both payroll funding and keeping all pretax the numbers for conversion are appealing.
To each their own.
How the tax incurred from Roth conversion should be funded for optimal result?
a – from an after tax brokerage account
b – directly from the source Pre-tax IRA account
Best source of advice would be a tax professional.
Our family pays for conversion tax from cash we keep on hand. We dont want to pull it from the conversion. It dilutes the long term benefit.
I was under the impression the amount you could contribute to an IRA was limited by earned income.
Our family’s plan is to match, and invest in index funds, our kids’ income dollar-for-dollar in custodial Roth IRAs until they’re earning “real” post-college salaries at which point they can take over. That should give them in the neighborhood of $15-20K that can then continue compounding for another 40+ years.
How does your 5 year old have $6K in earned income? I was under the impression the amount you could contribute to an IRA was limited by earned income.
Our family’s plan is to match, and invest in index funds, our kids’ income dollar-for-dollar in custodial Roth IRAs until they’re earning “real” post-college salaries at which point they can take over. That should give them in the neighborhood of $15-20K that can then continue compounding for another 40+ years.
We have an online media company and pictures and videos is a part of the media.
For those of you with corporate 401K plans with after-tax contributions saved in the plan, this might be something to consider. I recently rolled a corporate 401K from my employer plan into a self-directed IRA through Fidelity. Since Fidelity managed the 401K for my company, one phone call to Fidelity was able to process this in about 15-20 minutes.
Fidelity reminded me that I had ~$160K in after-tax contributions and wanted to know if I wanted to open a Roth account and roll that money there, which is what I did. The pre-tax money went into a Traditional IRA and the post-tax went to a Roth. If Biden is going to change or limit this in 2022, now is the time to consider this for yourselves. Between my wife and me, I have 2 other corporate 401Ks that I am probably going to follow the same process.
It is unlikely Biden is going to change this. What you did is not a Roth conversion. You did what the IRS and your accountant call an “in-service distribution”.
The key is that the status of your money you moved doesn’t change. The portion of your money that was after-tax in your company’s regular 401-k keeps its after-tax status when rolled over to your Roth. There is no tax consequence for what you did since no conversion of that money occurred and its tax status didn’t change.
By contrast, the portion of your money that was pre-tax in your 401-k does become taxable as regular income when you convert it to a Roth.
Most individuals have only pre-tax money in their regular 401-k accounts, but diligent savers can accumulate after-tax money. It is worth checking your 401-k account to see. Many 401-k administrators don’t notify you of this status, except when you request a conversion. You can also do a rollover of the after-tax portion only, and leave intact in the 401-k the pre-tax portion. Check with your admin.
One tax reduction strategy when doing a Traditional to Roth conversion is factoring in businesses losses. If you own an LLC or an S-Corp and have suffered losses in a taxable year, it might be a good time to do a conversion. Since LLCs and S-Corps are pass-through entities, business taxes are reported on your 1040 form. If you have business losses, it would just be subtracted from your gross income.
I personally went through this in 2019. I converted $32K from Traditional to Roth. So that increased my overall income by $32K. The increase generated a $6K tax liability and my wife was freaking out! HA!
In that same year, my S-Corp had taken a $26K loss. in the end, the $26K was subtracted from the $32K. So in the end I only ended up paying about $1,400 in income tax.
It’s helpful to know how each line is calculated on the 1040 form. Now, I’ve left out a lot of details in the calculations, but I hope you get the general tactic. My tax returns are prepared by a CPA and I do review what he does.
Needless to say my eyes were opened once I figured this out.
Fascinating! Thanks for the tip. Unfortunately or fortunately, online media is a high margin business when it’s just you and your wife.
Your wife has an eagle eye for taxes!
You are wrong when the best time is for a conversion .
The BEST time is when you have little or no income AND the market has taken a major drop !
If you can beat that then let me know .
True. So perhaps the best time is coming up as we head into a global recession with stocks down 20% already.