Roth IRA Conversion

Individual retirement accounts have long been the preferred way to save efficiently for long-term expenses later in life. In 1997, the Taxpayer Relief Act was signed into law, and also created the Roth IRA. Named for William Roth, the Delaware senator who sponsored the bill, the Roth IRA allowed for an even more effective savings vehicle for the right investor. Traditional IRAs may also be converted to Roth type funds to the advantage of certain account holders.

Roth IRA basics

The primary difference between a Roth and a traditional IRA is how taxes on these funds are paid. In a traditional IRA, account holders simply deposit savings into the fund, up to a maximum of $5,500 (or $6,500 over the age of 55). Taxes are then paid on the withdrawals made from this account. A Roth IRA, by contrast, allows investors to pay taxes on the contributions as they are deposited, instead of when withdrawals are made. This could prove advantageous if the investor expects to enter a higher income tax bracket when they plan to begin making withdrawals from the fund. As such, the money deposited into a Roth IRA may be withdrawn at any time before the investor reaches 55 years old without incurring a tax penalty, unlike with a traditional IRA. However, earnings will still be subject to tax in this early withdrawal scenario.

Roth IRA conversions

Since Roth IRAs have only be around for less than 20 years, it’s likely that many investors who began saving in a traditional IRA will want to take advantage of the Roth IRA’s benefits. According to RothIRA.com, a website focused on providing advice to IRA investors, it is entirely possible to convert a traditional account to a Roth-type. As they explained, the IRS had formally placed a cap on an investor’s earnings if they wanted to convert, but this is no longer the case. Investors can now convert their traditional IRAs to a Roth no matter what their income is. With this out of the way, investors have two options for converting their IRA: They can either rollover their traditional IRA into a Roth account, or they can turn an inherited IRA into a Roth account.

Roth IRAs for beneficiaries

According to U.S. News & World Report, many wealthy individuals who don’t need to rely on the income from their IRAs can roll them into Roth-type accounts before they are passed onto family members. To do so, the account holder will simply have to pay taxes on the amount that is rolled into a Roth IRA. After this conversion is completed, beneficiaries like children or grandchildren can make withdrawals from the fund tax-free. They will also not be limited by the required minimum distribution amounts that traditional IRAs are subject to.

Where life insurance can come in

The Internet has evolved from what many saw as a passing fad to the biggest cultural shift seen in decades. Converting a traditional IRA into a Roth account has many benefits for estate planning purposes. Clients who wish to undergo this conversion should first make sure they have the liquid assets to pay the taxes on the fund. In some instances, clients may be able to use a life insurance plan to fund the conversion of an IRA to a Roth account. Depending on the precise financial situation of the client, the death benefit from a life insurance policy may be able to provide the funds needed to cover the full tax bill of a Roth conversion. In this case, a financial professional can oversee the transition in the absence of the original account holder.

For optimal results, clients interested in Roth IRA conversions should seek the advice of a financial professional.

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