In a previous email we sent out we discussed why we believe in filling up the tax-free bucket and we showed you compelling numbers from a hypothetical couple (VIEW THAT EMAIL HERE). This email outlines more about HOW to execute a nice conversion from the pre-tax bucket to the tax-free bucket.
 

The basic concept of a Conversion is that we are taking funds from a pre-tax account, like a Traditional IRA, paying the taxes and moving it into a tax-free account (Roth IRA). The highlights of why we do this are 1. Tax-free growth, 2. No Required Minimum Distributions (RMDs) forced by the IRS*, and 3. Not passing a potential tax bill to your heirs.

*Typically, at age 73.

In a perfect situation, we prefer to send the taxes owed on the conversion OUTSIDE of the Traditional IRA. That is, instead of withholding the taxes on the conversion, we move 100% of the conversion to the Roth IRA and send in the estimated taxes via our taxable bucket (checking, savings, individual investment account).

There are a couple of forms worth mentioning here that need to be filed to make sure that all this work “counts” as far as the IRS is concerned. We also want to avoid any penalties for the IRS not knowing what we are up to.

• IRS Form 8606 notifies the IRS that we have converted part of your Traditional IRA.
• IRS Form 2210 notifies the IRS that we took a distribution from an IRA and do not need to pay a penalty for not making estimated payments.

It is also worth mentioning that there are NO income limitations on conversion, and you can convert as much as you are willing to pay taxes on each calendar year. We know that this all seems like a lot of work, and to be honest, it is.  We have worked hard to develop the processes to analyze our clients’ tax situation each year to determine if this strategy makes sense. We then help them properly execute the moves and coordinate with their tax advisors. We also review everything the following year to ensure that everything is filed correctly.

Next up: REPLAY – Webinar: Creating a Tax-Free Retirement

Disclosures

This information is not intended to be a substitute for specific individualized tax advice. We suggest that you discuss your specific tax issues with a qualified tax advisor.

Traditional IRA account owners have considerations to make before performing a Roth IRA conversion. These primarily include income tax consequences on the converted amount in the year of conversion, withdrawal limitations from a Roth IRA, and income limitations for future contributions to a Roth IRA. In addition, if you are required to take a required minimum distribution (RMD) in the year you convert, you must do so before converting to a Roth IRA. (22-LPL) show less

Contributions to a traditional IRA may be tax deductible in the contribution year, with current income tax due at withdrawal. Withdrawals prior to age 59 ½ may result in a 10% IRS penalty tax in addition to current income tax.

A Roth IRA offers tax deferral on any earnings in the account. Qualified withdrawals of earnings from the account are tax-free. Withdrawals of earnings prior to age 59 ½ or prior to the account being opened for 5 years, whichever is later, may result in a 10% IRS penalty tax. Limitations and restrictions may apply.