How to convert to a tax-free Roth IRA

I’m writing this article to show you how easy it can be to have your own tax-free, no-strings attached Roth IRA waiting for you at retirement.

So why would you want to put money into a Roth IRA? After all, you don’t get a tax deduction. But what do you get in return? A $5,500 Roth contribution at age 30 that grows at 8% on average will be worth almost $100,000 at age 66. Let’s say you give up 25% in taxes, or $1,375. I’ll take $100k at retirement in exchange for $1,375 today; how about you? Even at age 40, you’ll have about $44,000 by age 66. If you wait until age 50, you’ll still have over $20,000 for the $1,375 in foregone taxes. And lest you forget, the money in your Roth is 100% tax-free.

But the annual limit on Roth contributions is $5,500 ($6,500 if you’re age 50+). What if you want to get more into your Roth? Good news – you can! I’ve got a great technique for super-funding a Roth IRA and it’s called a Roth Conversion. A conversion refers to moving money from a pre-tax IRA into a Roth IRA. You are simply moving funds from one account into another. Because you are moving money that you have already deducted on your tax return, anything you convert will be taxed to you as income for the year you convert (transfer) money from a pre-tax IRA into a Roth IRA.

Hold on…taxes? Yes, you pay your tax bill in advance when your balance is small and reap the multiplying effect of long-term, tax-free growth at retirement. And here’s an extra bonus: the IRS does not require you to take those onerous RMDs (Required Minimum Distributions) from your Roth IRA at age 70 ½ – or ever. That makes Roth IRAs the ideal gift for your heirs. Who wouldn’t want to inherit tax-free money?

If you still need convincing that Roth IRAs are a great way to save, here’s another benefit: you can always remove original contributions from your personal Roth IRA penalty- and tax-free. For converted funds, you need to wait five years, but that’s better than the tax and penalty you’ll pay if you need to raid your pre-tax IRA.

Is this a no-brainer? Nope. Roth IRA conversions pay off best with careful tax planning, such as when you have a low income year. For example:

  • You’re in between jobs
  • Your small business has a bad year
  • After you retire
  • When you have a baby and move from a couple working to a one-paycheck family

Where does the money to convert to a Roth IRA come from? Typically, from a 401k or 403b that you’ve rolled out to an IRA after a job change. These accounts are a perfect start to super-funding your Roth IRA. You can convert them all in one year or a chunk at a time, depending upon your tax bracket. Another trick is to convert when the market drops – you can be sure Milestones will be busily converting in the next bear market.

Of course, 8% growth doesn’t happen by accident. You have to understand how to allocate your money, manage your portfolio, and, most importantly, be patient. You can learn how we do this at Milestones in my video, Our 3-Step Investing Process.

So what if you convert to a Roth IRA and change your mind? Or your income is higher than you had planned? It’s not so bad – the IRS gives you a mulligan. If you’re not a golfer – or even if you are – my video will tell you what to do.

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