I commend you for your diligent record-keeping and awareness of the various types of taxed and non-taxed contributions to your IRA. It is crucial to maintain organized records of these contributions, as highlighted by financial planners. By doing so, you are already ahead in the game.
Having a clear understanding of the basis you have in your IRA before considering a Roth conversion is advantageous. Brandon Opre, a certified financial planner and the founder of TrustTree Financial, emphasizes this point. “Knowing the basis in advance of a Roth conversion is helpful,” he explains. Without this knowledge, it becomes a cumbersome task to sift through decades worth of records in order to calculate the client’s basis. The basis represents the after-tax balance in your account.
Converting to a Roth IRA
If you decide to convert your traditional IRA to a Roth IRA, you may be wondering how the tax implications will be handled. Specifically, you are curious if you will only be required to pay tax on the $30,000 difference between your pre-tax and after-tax contributions. This is indeed the case. By converting the account, you would only need to pay tax on that portion.
Moreover, assuming you do not make any withdrawals from your Roth account before reaching 59 and a half years old, all subsequent withdrawals, including both contributions and earnings, would be tax-free.
Traditional 401(k) Conversion
Furthermore, you mentioned your intention to convert your significant traditional 401(k) into a traditional IRA following your departure from your former job. However, you express concern about potential taxes due to the reduced after-tax basis of the account (approximately 10%).
To address this, it is important to note that converting both your traditional IRA and traditional 401(k) into a Roth IRA within the same tax year can potentially provide you with certain benefits. By first converting your current traditional IRA to a Roth IRA, you would only be taxed on the $30,000 difference. Subsequently rolling over your traditional 401(k) into the traditional IRA would also be taxed at the same amount.
It is crucial to keep in mind that if you choose to pursue this strategy, it should be completed within a single tax year. Failure to do so may result in the need for additional tax planning in subsequent years.
In conclusion, your proactive approach to managing your IRA contributions and considering various conversion strategies is commendable. By staying informed and seeking professional advice, you can make the most out of your retirement savings.
Wishing you continued success in your financial journey.
Related: We’re in our 70s, have $1.3 million in IRAs and $1.15 million in cash. But we have ‘no clue’ what to do with the money.
Maximizing Retirement Savings: A Strategic Approach
Having a mix of after-tax and pre-tax contributions in your traditional accounts introduces the pro-rata rule. According to this rule, any withdrawal (whether it’s a conversion or distribution) will consist of a percentage of tax-free and taxable dollars based on the account’s division. To optimize your savings, it is advisable to direct after-tax contributions to a Roth IRA.
Determining what to do with the remaining pre-tax money is a decision you should make, possibly in consultation with your accountant. Remember that depending on your current tax bracket, there’s a chance you might face a higher tax liability. To prevent pushing yourself into a higher bracket, you should carefully consider whether converting the remaining $30,000 is advantageous.
A Thoughtful Two-Year Plan
However, there are several moving parts involved here. You need to transfer funds between IRAs and a 401(k) plan. Achieving your goals will likely span two tax years, as suggested by Maureen Demers, a certified financial planner and owner of Demers Financial Planning. You’ll first need to complete the Roth conversion before December 31st and then proceed with rolling over the 401(k).
To avoid any taxable events during conversions, it is essential to keep your 401(k) separate from the IRA with after-tax contributions. Erika Safran, founder and principal at Safran Wealth Advisors, recommends considering “back-door Roth conversions” for the IRA funded with after-tax dollars. These conversions involve using converted dollars that were originally after-tax contributions in a traditional account.
Do not overlook your standing within the IRA. If any after-tax contributions from your 401(k) were transferred to a traditional IRA instead of a Roth, you would encounter the pro-rata rule again. Conduct a thorough review of your account to ensure optimal tax advantages.