Should I convert to a Roth account during my rollover?
During your rollover, you have the option to transfer your employer-sponsored traditional account balance into a Roth IRA account.
The difference between traditional and Roth lies in the way it is taxed:
- A traditional account is pre-tax, meaning your money is tax-deferred the year you contribute, but you will need to pay taxes on your withdrawals from the account when you retire.
- A Roth account is post-tax, requiring you to pay taxes on your contributions today in exchange for tax-free withdrawals when you retire.
What should I know about a Roth conversion?
If you have been saving tax-free in a traditional retirement account, converting to a Roth account could be a big shift for your finances. The year you perform a Roth conversion, you'll be taxed on your entire retirement balance. Hence, it is an important decision that should be carefully considered, and we recommend calculating the resulting conversion tax before making a choice.
Example: You’re in the 22% tax bracket, and convert $20,000 to Roth. Your income for the tax year will increase by $20,000. Assuming this doesn’t push you into a higher tax bracket, you’ll owe $4,400 in taxes on the conversion.
You should
only convert to a Roth account if:
- 1
- You anticipate being in a higher tax bracket when you retire. If you anticipate that your career trajectory will land you in a higher tax bracket when you retire, a Roth might be right for you. By paying lower taxes on your nest egg now, you'll be able to enjoy your savings tax-free when you finally withdraw.
- 2
- You are at a low tax bracket now. For instance, if you expect your income level to be lower in a particular year but increase again in later years, you can initiate a Roth conversion to capitalize on the lower income tax year and then let that money grow tax-free in your Roth IRA account.
- 3
- You can afford to pay the conversion tax. You'll owe income tax on any money you convert, and future savings in your Roth account will not be tax-deferred. If your budget allows for this change, you'll be able to perform a Roth conversion.
- 4
- You have a lower retirement balance. Workers just beginning their savings journey will likely have less saved in retirement accounts, and, therefore, they'll have a lower amount to pay in taxes. If this sounds like you, now could be the right time to convert to a Roth account.
Note:
Once you decide to do a Roth conversion, it doesn’t mean you can definitely roll your old 401(k) into a Roth IRA no matter what. Unfortunately, it all depends on your plan administrator. Many 401(k)’s and 403(b)’s come with the same “No-Roth IRA Rollover” option. In those situations, the only option is to open a traditional IRA to accept the rollover and immediately convert it to a Roth IRA. Manifest does not support IRA rollovers, but our team is happy to provide guidance!
The frequently asked questions, or FAQs, are intended to be helpful and to get you thinking in a more sophisticated manner about your account transfer and related issues. However, these are not meant for accounting, tax, finance, or legal advice, are not intended to be exhaustive and do not create any relationship or duty on our part to assist your particular situation. We offer no warranties on the accuracy or completeness of the information as there could be developments of any kind, including, but not limited to, any changes in relevant laws and regulations.