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Roth Conversions: Should Pre-Retirees Consider One This Year? Thumbnail

Roth Conversions: Should Pre-Retirees Consider One This Year?

As the year draws to a close, many pre-retirees are evaluating their financial strategies, especially when it comes to taxes and retirement savings. One of the most important moves to consider before the end of the year is whether a Roth conversion makes sense for you. A Roth conversion allows you to transfer funds from a traditional IRA or 401(k) into a Roth IRA, with the trade-off of paying taxes now to enjoy tax-free withdrawals in the future.

Why Consider a Roth Conversion?

  1. Tax Rates and Market Conditions: If you believe your tax bracket will increase in the future or if you're concerned about potential tax hikes, converting now at today’s rates could save you money in the long run. Pre-retirees often experience a "sweet spot" between retiring and starting Social Security or RMDs (required minimum distributions), where they may be in a lower tax bracket than in later years.
  2. Lower Market Values: If your retirement portfolio has taken a hit due to market fluctuations, converting investments to a Roth IRA while their values are lower could be a strategic move. This allows you to pay taxes on a reduced balance, then benefit from the tax-free growth of those assets when the market recovers.
  3. Future Tax-Free Withdrawals: Unlike traditional IRAs, Roth IRAs do not require RMDs during your lifetime. This flexibility can give you more control over your retirement withdrawals and potentially lower your future tax burden.

Things to Keep in Mind

  • Immediate Tax Implications: When converting, you’ll owe taxes on the amount moved from the traditional IRA to the Roth IRA. It’s essential to ensure that you have enough cash on hand to cover the taxes without tapping into the converted funds, which could reduce the future growth potential.
  • The Five-Year Rule: Converted funds must remain in the Roth IRA for at least five years before you can withdraw them tax-free. If you need access to these funds earlier, you may face penalties. This is a critical consideration if you’re approaching retirement and planning to access these funds soon.
  • April 2025 Deadline: If you’re thinking of making a conversion for the 2024 tax year, remember that the deadline is December 31, 2024. Unlike IRA contributions, Roth conversions cannot be backdated to a previous tax year after that deadline.

Is It the Right Move for You?

Deciding whether a Roth conversion is a good strategy for you depends on several factors, including your current and future tax bracket, retirement timeline, and overall financial plan. It’s crucial to consult a financial advisor to understand the impact on your specific situation and ensure you’re making the most tax-efficient choices.