| The recent stock market meltdown has likely put a big dent in many retirement savings plans. However, this latest volatility may actually be a prime opportunity for a Roth individual retirement account conversion, some money experts say.
Here's how it works: An investor makes what's known as non-deductible contributions to a pre-tax IRA before converting the funds to a Roth IRA, kickstarting tax-free growth. The trade-off is that Roth conversions trigger an upfront tax bill on contributions and earnings. The bigger your pre-tax balance, the more you'll owe for the conversion.
The strategy involves changing a traditional, pre-tax retirement account — such as a 401(k) plan or a qualified IRA — to an after-tax Roth fund. The move allows higher earners to sidestep the earnings limits for Roth IRA contributions, which are capped at $144,000 modified adjusted gross income for single investors and $214,000 for married couples filing together in 2022.
Roth IRA conversions have several advantages: portfolio diversification, alleviating concerns of future tax rates, keeping your current tax bracket and having no required minimum distributions.
While you can begin taking distributions from your Roth IRA at any time, any earnings you withdraw are considered "qualified" — or tax-free and penalty-free — if the account is at least five years old and you are older than 59½, disabled, buying your first home or you inherited the Roth IRA. However, if you're younger, you have to keep the funds in your new Roth IRA for five years and make sure that you've reached age 59½ before taking out any money. Otherwise, you'll be charged not only taxes on any earnings but also a 10% early distribution penalty.
A Roth IRA conversion can be a very powerful tool for your retirement. If your taxes rise because of increases in marginal tax rates — or because you earn more, putting you in a higher tax bracket — then a Roth IRA conversion can save you considerable money in taxes over the long term.
The so-called "backdoor" strategy opens the Roth door to high-earners who normally would be ineligible for this sort of IRA, or who are unable to move money into a tax-free account by any other means.
A Roth IRA conversion isn't for everyone. It may not make sense for you if you are in your peak earning years. Also, if you're nearing retirement and plan to access your retirement funds in the near future, it does not make sense to convert to a Roth IRA since you cannot access your converted funds penalty-free for up to five years after the conversion.
It's complicated. That's why you need to do some research and weigh the advantages and disadvantages of a Roth IRA conversion.
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