Moving Traditional Investments to Roth Investments: Your Guide to Roth Conversions

Haven’t you heard? There’s a tax sale going on right now! Okay, so there isn’t actually a “tax sale,” but in many cases taxes are historically low right now.

This has got a lot of people asking, Should I be changing some of my investments to an after-tax option? While we often advocate for this, the answer isn’t always so black-and-white.

Here’s your guide to Roth conversions:

Giving Uncle Sam His Share

Taxes can’t be avoided when it comes to your finances. Like Phil Cooper, Founder of 210 Financial, often says, “Give to Caesar what’s Caesar’s, and not a doggone dime more!”

When it comes to retirement planning, there are two key types of investments and how they handle taxes is very different. The first is an investment that is tax-deferred. This means that you don’t pay taxes on your investment until you start taking money out. These would be investments like a Traditional IRA or a 401(k). The second type of an investment is an after-tax investment such as a Roth IRA. After-tax means that you pay all the taxes up-front when you invest the money. When you start making withdrawals, you won’t have to pay any additional taxes. (There are potentially other factors to be sure to consider, like age you can start taking out withdrawals, how long the account needs to be open, and any additional fees that could be incurred.)

A tax-deferred investment is a great choice if the current tax environment is higher than you think it will be in the future or if it is better for you to avoid paying taxes right now. On the flip side, an after-tax investment is a great choice if the current tax environment is lower than what you think it will be when you will start making withdrawals.

When thinking about the current historically-low tax environment we find ourselves in, you have to ask yourself: Do you think taxes are going to get higher or lower by the time you start making withdrawals?

Up to this point, we’ve reviewed the two types of investments in relatively black-and-white terms. What is causing a lot of people to consider a major shift in their investment strategy is the historically-low tax rate. Due to the current tax rate, many people are changing their tax-deferred investments over to an after-taxed option; this is called a Roth Conversion.

What is a Roth Conversion?

To put it simply, a Roth Conversion is when you take another type of investment, such as a Traditional IRA or a 401(k), and withdraw your money from that tax-deferred investment and then put it into a Roth IRA.

The benefit of converting your tax-deferred investments into an after-tax Roth IRA is that you can take advantage of the “tax sale,” as we call it. However, while taxes may be comparatively low, this doesn’t always mean that the right choice is to convert all of your investments to Roth accounts. There are many factors that you need to consider before deciding if a Roth Conversion is right for you.

Looking for more resources? We chat about Roth Conversions at the beginning of this podcast episode.

If the show notes for this episode are on the 210 site when this is being prepared, please link to the show notes rather than the YouTube video.

Is a Roth Conversion the Right Move for Me?

The answer is maybe. Every person’s financial situation is different and a Roth Conversion won’t benefit everyone. There are a few factors that can affect whether or not a Roth Conversion might be right for you.

One of the most important considerations of a Roth Conversion is that when you pull your money from a tax-deferred investment, all of the taxes are due at the time you make a withdrawal. This doesn’t mean that you can’t spread conversions out over time to limit the impact in a single month, but it’s an important reality to consider. Depending on your unique financial situation, you may or may not be able to pay that hefty of a tax payout all at once.

As a clear example: If you are just a few years away from retirement, you likely won’t see that great of a benefit from making a Roth Conversion.

After you make a Roth Conversion, you are required to wait five years to make a withdrawal to avoid a penalty . Depending on your financial situation, it may not be prudent to put yourself in a situation where you have inaccessible funds.

Every person and every situation is unique. If you are wondering if a Roth Conversion is the right financial move for you, please take a moment to schedule a complimentary Retirement Blueprint Financial Review with our team.

You can also download our full guide to Roth Conversions here.

Please remember that converting an employer plan account to a Roth IRA is a taxable event. Increased taxable income from the Roth IRA conversion may have several consequences including (but not limited to) a need for additional tax withholding or estimated tax payments, the loss of certain tax deductions and credits, and higher taxes on Social Security benefits and higher Medicare premiums. Be sure to consult with a qualified tax advisor before making any decisions regarding your IRA. Neither the firm nor its agents or representatives may give tax or legal advice. Individuals should consult with a qualified professional for guidance before making any purchasing decisions.

210 Financial is an independent financial services firm that utilizes a variety of investment and insurance products. Investment advisory services offered only by duly registered individuals through AE Wealth Management, LLC (AEWM). AEWM and 210 Financial are not affiliated companies. 1344181 – 5/22

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