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Is Now a Good Time for a Roth IRA Conversion?

The end of the year is drawing near, and so is the deadline to make key retirement moves like Roth IRA conversions. If you’ve been considering one, you have to act before Dec. 31 if you want the conversion to count for 2023. Below, we’ll look at how a Roth IRA conversion could affect you now and in retirement, so you’ll know if it’s right for you.

How Roth IRA conversions work

A Roth IRA conversion changes how the government treats some of your retirement savings by moving the money from a tax-deferred, traditional IRA or 401(k) to a Roth IRA. The primary difference between these accounts is when you pay taxes on your funds. Traditional IRAs and 401(k)s give you a tax break upfront, but in exchange, you must pay taxes on your withdrawals in retirement. Roth IRAs, on the other hand, require you to pay taxes on your contributions upfront but then give you tax-free access to your contributions and earnings in retirement.

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The chance for tax-free withdrawals makes Roth IRA conversions appealing, but in order to do them, you must pay taxes on the amount you’re converting this year. This will raise your tax bill, and it may even push you into a higher tax bracket. That would cause you to lose a larger percentage of your income to the government.

No one wants that to happen, which is why most people wait until the end of the year to do a Roth IRA conversion. By this point, they have a pretty good idea of what their annual income and tax bracket will be. They can then use this to guide them when deciding how much they’d like to convert that year.

Ideally, you want to stay within your current tax bracket, so you should convert just enough to take you up to the top of it. If you have more you’d like to convert, break it into chunks and do it gradually over a few years.

Rules about accessing converted Roth IRA funds

Roth IRAs have what’s known as five-year rules that determine when you can withdraw your earnings from the account without penalty. When contributing directly to a Roth IRA, you must wait until you’ve had the account for at least five years before you can withdraw your earnings without tax repercussions.

For Roth IRA conversions, each conversion has a five-year clock, and you can’t take that money out until the time is up. But the five years doesn’t begin on the day you convert the funds. It actually starts on Jan. 1 of that year. So even if you waited until December to do a Roth IRA conversion, your five-year countdown would still begin on Jan. 1, 2023, and you’d be able to take your money out penalty-free starting Jan. 1, 2028. So effectively, your money is only locked up for four years instead of five. This is another reason why the end of the year is a popular time for Roth IRA conversions.

How to do a Roth IRA conversion

In order to do a Roth IRA conversion, you need to first open a Roth IRA if you don’t already have one. It’s probably easiest to keep the money in an account with the same provider you already have your traditional IRA with, but this isn’t required.

Contact your old and new retirement plan administrators and let them know of your intention to do a Roth IRA conversion. You will need to fill out some paperwork, and you may need to pay a one-time fee to do this. If you have any questions, ask your plan administrator.

This process can take a few days to a few weeks, so it’s best not to wait until the final week of December to try it. If you think a Roth IRA conversion is right for you, start planning right away to be sure you have it completed before the year is over.

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