Hello blog friends! I don’t want to beat around the bush today because I can barely contain my excitement. Today we’ll be talking about one of Dash Capital’s favorite things. It’s making me tear up just thinking about it – the Roth IRA.
Now, we won’t be DIRECTLY talking about the Roth today because I’m sure most of you know the basics of the account. If you don’t, check out everything you need to know here 😊
In all seriousness, today’s blog will be about the basics of a strategy called the Roth Conversion. For those of you who don’t know the Roth Conversion is defined as: moving money from a traditional retirement account, into a Roth account, and you pay INCOME TAX on the amount converted.
Well, why is that so amazing? Because it ensures that EVERYONE can take a slice of the Roth IRA pie. Why do we use the Roth? To lower the $ amount we pay in taxes…eventually.
Here are TWO reasons you should use the Roth Conversion strategy:
- The Backdoor Roth
This is for all the high-income earners. As you probably know the income limit to contribute to a Roth IRA (filed single) is $139,000. So what if you make above the amount and you don’t have the Roth 401(k) through work? Enter: The Backdoor Roth.
FIRST: Open a Traditional IRA, and come tax season DO NOT take a deduction for your contributions. Unlike DEDUCTIBLE contributions to a traditional IRA which you’re probably used too, NON-Deductible contributions do NOT reduce your taxable income. If you’re a high income earner, you probably do not have the option to make deductible contributions, hence the need for the non-deductible contributions to an IRA.
SECOND: Do conversion paperwork! It’s that simple. Once you’ve made contributions to your “Non-Deductible IRA” and are ready to convert (assuming you already have a Roth IRA opened), simply fill out the proper paperwork associated with your broker-dealer!!
The “Backdoor Roth” conversion strategy is a non-taxable event (since you did not take a deduction for your contributions), and after completed effectively works the exact same way as if you contributed directly to a Roth IRA. It is important to note that in most cases this only makes sense to do when you don’t already have a Traditional IRA.
- You Like Tax-Free Money and:
- you are an individual who will continue climbing the income ladder. it usually makes sense to try and pay as much taxes now while you’re still in the lowest marginal tax bracket. If you have money in an old IRA or 401(k), it may make sense to do a Roth Conversion, pay the income tax now, and let the money grow forever in a Roth account. However, it makes the most sense to do this at the end of the year so you know what tax bracket you’ll be in and the conversion won’t push you up any higher.
- you want to eliminate political tax risk. No one knows where taxes are going to go in the future. However, we like the idea of forgoing having to stress about it at all by participating in the Roth IRA. Even more of a reason to convert some or all your pretax $’s over while your income is low! Check out historical tax brackets, and see where they’ve been.
**Unlike the “Backdoor Roth IRA” this is an income taxable event at conversion**
And there you have it! It's that simple. Once you do your Roth conversions, your dollars are now available for tax free distributions in retirement! Not only do you not pay income tax on distributions, but you also avoid RMD's (required minimum distributions) allowing for your account to continue growing tax deferred for a longer period (It’s all about keeping gains in the portfolio). Take that income limits!
*As a rule of thumb you want to do conversions in years your income is at it’s lowest or during a down year in the market to minimize your tax liability. *
Okay you can blink now; the blog is over! AS always, please feel free to reach out to the Dash team if you have any further questions. After reading this we hope the Roth is now your favorite thing as well – or at least in the top 5!