Roth Conversion Calculator
Conversion Summary:
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A Roth conversion is a powerful financial strategy that allows you to move pre-tax money from a traditional Individual Retirement Account (IRA) or 401(k) into a Roth IRA. While this move triggers an immediate tax liability, it offers the significant benefit of tax-free withdrawals in retirement, regardless of how much your investments have grown.
How Does a Roth Conversion Work?
When you contribute to a traditional IRA or 401(k), your contributions are often tax-deductible, meaning you don't pay income tax on that money in the year you contribute. The money then grows tax-deferred, and you pay taxes on both your contributions and earnings when you withdraw them in retirement.
A Roth conversion reverses this. You convert a portion or all of your traditional IRA/401(k) balance into a Roth IRA. The amount you convert is added to your taxable income for that year, and you pay income tax on it at your current marginal federal and state tax rates. Once the money is in the Roth IRA, it grows tax-free, and qualified withdrawals in retirement are completely tax-free.
Why Consider a Roth Conversion?
- Expected Higher Future Tax Rates: If you believe your income tax rates will be higher in retirement than they are today, paying taxes now via a Roth conversion can save you money in the long run.
- Tax-Free Growth and Withdrawals: All qualified withdrawals from a Roth IRA in retirement are tax-free. This provides predictability and can be a significant advantage, especially for those who accumulate substantial wealth.
- No Required Minimum Distributions (RMDs): Unlike traditional IRAs, Roth IRAs do not have RMDs for the original owner. This means you can leave the money in your Roth IRA to continue growing tax-free for as long as you wish, or pass it on to heirs tax-free.
- Estate Planning Benefits: Roth IRAs can be an excellent tool for estate planning, as beneficiaries can often inherit the account and continue to take tax-free withdrawals.
- Flexibility: After five years, you can withdraw your converted contributions from a Roth IRA tax-free and penalty-free, regardless of your age. This offers a level of liquidity not found in traditional IRAs.
Key Considerations Before Converting
- Current Tax Bracket vs. Future Tax Bracket: The core decision hinges on whether you expect to be in a higher or lower tax bracket in retirement. If you're in a temporarily low tax bracket now (e.g., due to unemployment, a sabbatical, or a business loss), it might be an ideal time to convert.
- Paying the Taxes: It's generally recommended to pay the taxes on the conversion from funds outside your IRA. If you pay the taxes from the converted amount itself, that portion is not invested in the Roth, reducing its future tax-free growth potential.
- Impact on Current Income: A large conversion can significantly increase your taxable income for the year, potentially pushing you into a higher tax bracket, affecting other deductions, or increasing your Medicare premiums.
- Five-Year Rule: For each conversion, a separate five-year waiting period applies before earnings can be withdrawn tax-free and penalty-free. However, converted contributions can be withdrawn tax-free after five years, regardless of age.
How to Use the Roth Conversion Calculator
Our Roth Conversion Calculator helps you estimate the immediate tax impact and the long-term growth potential of converting a portion of your traditional retirement savings to a Roth IRA. Here's how to use it:
- Amount to Convert: Enter the specific dollar amount you are considering converting from your traditional IRA or 401(k) to a Roth IRA.
- Current Federal Income Tax Rate: Input your current marginal federal income tax rate as a percentage. This is the rate applied to your last dollar of income.
- Current State Income Tax Rate: If your state levies an income tax, enter your marginal state income tax rate as a percentage.
- Expected Annual Growth Rate of Roth IRA: Provide an estimated annual rate of return you expect your Roth IRA investments to achieve. A common assumption is 5-7% for diversified portfolios.
- Years Until Retirement: Enter the number of years you anticipate until you begin withdrawing funds in retirement.
The calculator will then provide you with an estimate of the taxes you'll owe on the conversion and the projected future value of that converted amount in your Roth IRA, growing tax-free until retirement. This tool is designed to give you a clearer picture of the financial implications, helping you make an informed decision about your retirement planning.