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If I have a tax-deferred 401(k). Can I convert it to a Roth IRA without paying tax-deferred when I return it?
-Tommy
Generally, the answer here is no. There is usually no method to completely avoid taxes on a Roth conversion. Eventually, Uncle Sam will come to cash in on your tax-deferred retirement accounts, either when you perform a Roth conversion, withdraw funds, or collect your minimum distributions required (RMD).
That said, your inability to fully avoid taxes does not translate into an inability to reduce them. Here are some smart strategies to lower your tax bill on a Roth conversion. (For more information on taxes and retirement, consider working with a financial advisor.)
Strategies to lower your tax bill on a Roth conversion
To reduce the tax consequences of rolling over a tax-deferred account to a Roth, consider these methods:
Perform a tax-aware partial Roth conversion
one strategy to reduce the tax liability of a Roth conversion it involves spacing out your changes over several years. To use this strategy, convert just enough to push your total income up to the limits of your current tax bracket without going into the next bracket. (For more information on taxes and retirement, consider working with a financial advisor.)
Roll your money over in a low-tax year
For many people, a prime time for Roth conversions it takes place during the years after retirement but before Social Security and RMDs start. These may be years of relatively low income during which starting a conversion can result in a triple profit. These benefits are: lower tax bills, reduced RMDs and tax-free future growth.
Speaking of weather, if you suspect that tax rates will rise at the expected sunset of the Tax Cuts and Jobs Act or because of political machinations on Capitol Hill, doing a Roth conversion may now be an option.
You’ll lock in your current tax rate and hopefully avoid any future increases. Keep in mind that no one has a crystal ball, and this strategy involves making predictions about the future. (For more information on how tax policy can affect retirement planning, consider working with a financial advisor.)
Pay your tax wisely
Many experts recommend paying the tax on the Roth conversion with non-retirement assets. This is opposed to withholding some of your retirement funds to pay the bill. This will allow you to move the larger amount into your new Roth account and continue to see it grow tax-free.
Work with a financial advisor
A financial advisor can help you take a holistic view of your tax and retirement profile, identifying opportunities to minimize taxes and adhere to an investment philosophy that matches your life stage.
