It’s an action you may thank yourself for later.
401k, IRA: How to choose the best retirement plan for you
There are a variety of retirement savings plans, including traditional IRAs, Roth IRAs, and 401k’s. Here’s how to choose the one that will help you achieve your goals.
Converting money from a traditional IRA or 401(k) to a Roth IRA means paying taxes up front instead of withdrawing them tax-free later. And in some situations, it makes sense.
When making a Roth conversion, it’s important to weigh the benefits against the short-term taxes. But if these signs apply to you, converting to a Roth can be a very smart idea.
1. Higher taxes are expected to apply in the future
There are many reasons why you may be owed higher taxes as a retiree than you currently are. For example, if you’ve saved well for retirement and expect to take large withdrawals from your savings, sticking with a traditional IRA or 401(k) could leave you with a large IRS bill each year.
With a Roth conversion, you pay the current tax rate on the money you move. If your current tax rate is lower than your expected future tax rate, converting to a Roth may be easier.
2. I want to increase my flexibility after retirement
Traditional IRAs and 401(k)s end up forcing savers to take required minimum distributions (RMDs). For some people, that doesn’t matter because they need to draw from their savings to survive.
But when RMDs come into play, you could be forced to withdraw more money than you want or need each year. You’ll also be hit with a tax bill on every withdrawal from your traditional IRA or 401(k), which can end up being a headache.
Converting to a Roth means you don’t have to deal with RMDs. In years when you don’t need the money, you can withdraw as much as you like or leave your savings unutilized.
3. Leaving a legacy is important to you
Traditional IRAs and 401(k)s can make estate planning more difficult. Even if you aren’t forced to take RMDs, having to remove that money from your retirement account can make inheritance arrangements difficult.
With a Roth IRA, you don’t have to take RMDs, so you can save as much as you need for inheritance purposes. Additionally, your heirs have 10 years to empty the Roth IRA you leave behind, giving them the opportunity to grow those funds into larger amounts and enjoy tax-free withdrawals.
Strategically time your conversions
Converting to a Roth isn’t necessarily the right choice for everyone, but if any of the above situations apply to you, it could pay off. However, be sure to time your conversion carefully.
Aim to move the funds into years of lower income and spread the conversion over several years to minimize the tax burden. With proper planning, a Roth conversion can be one of the smartest retirement moves.
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