Annual Roth conversions may manage tax exposure, but do not eliminate tax
SmartAsset says converting part of a 401(k) to a Roth IRA can remove required minimum distributions for those assets, but tax is paid upfront and suitability depends on individual circumstances.
Converting 10 per cent of a 401(k) to a Roth IRA each year may help some investors manage future tax exposure, according to financial guidance from SmartAsset published by Yahoo Finance.
The strategy does not avoid tax. Funds moved from a pre-tax account are added to taxable income in the year of conversion, creating an upfront bill and requiring investors to have cash available to meet it.
Once converted, the assets can grow tax-free and qualifying withdrawals are generally not taxed. Roth IRA assets are also exempt from required minimum distributions, meaning conversions can remove those requirements for the funds moved out of a 401(k).
SmartAsset says staggering conversions may help investors remain in lower tax brackets than they might face after converting a larger amount at once. The approach can also carry costs, including the loss of capital used to pay tax and a potential five-year restriction on withdrawals.
Whether converting 10 per cent annually is appropriate depends on factors including income, age, retirement timing, available cash and financial goals. The guidance presents Roth conversions as a way to restructure the timing of tax payments, rather than as a means of avoiding them.
