I do have a tax-deferred 401(k). Can I convert it to a Roth IRA tax-deferred when I roll it over?
-Tommy
In general, the answer here is no. Generally, there is no method to completely avoid tax on a Roth conversion. Eventually, Uncle Sam will come to collect your tax-deferred retirement accounts, whether it’s when he executes a Roth conversion, withdraws funds, or collects your required minimum distributions (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 moving a tax-deferred account to a Roth account, consider these methods:
Execute a Tax-Conscious Partial Roth Conversion
One strategy to reduce the tax liability of a Roth conversion it involves spacing out your transfers over several years. To use this strategy, convert only enough to bring your total income within the limits of your current tax bracket without moving into the next bracket. (For more information on taxes and retirement, consider working with a financial advisor.)
Reinvest your money in a year with low taxes
For many people, a prime time for Roth conversions takes place during the years after retirement but before Social Security and the RMDs are activated. Those can be relatively low income years during which starting a conversion can result in a triple payoff. Those benefits are: lower tax bills, reduced RMDs, and tax-free future growth.
Speaking of timing, if you suspect that tax rates will increase on the anticipated expiration date of the Tax Cuts and Jobs Act or due to political machinations on Capitol Hill, doing a Roth conversion may now be an option.
It will lock in your current tax rate and hopefully hold up to any future increases. Keep in mind that no one has a crystal ball, and this strategy is to make predictions about the future. (For more information on how tax policy can affect retirement planning, see consider working with a financial advisor.)
Pay tax wisely
Many experts recommend paying the tax on your Roth conversion with non-retirement assets. That’s as opposed to withholding some of your retirement funds to pay the bill. This will allow you to move as much of it as possible into your new Roth account and continue to watch it grow tax-free.
Work with a financial adviser
a financial adviser can help you take a holistic view of your tax and retirement profile, identifying opportunities to minimize taxes while adhering to an investment philosophy that matches your stage of life.
A good advisor can tell you if a Roth conversion makes sense right now. He or she can also discuss alternatives, such as converting your 401(k) to a traditional IRA, transitioning to a new employer account 401(k) or do a partial conversion.
Tips for handling taxes in retirement
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Consider a few advisors before settling on one. It’s important to make sure you find someone you trust to manage your money. When considering your options, These are the questions you should ask an advisor to make sure you make the right choice.
Susannah Snider, CFP® is a financial planning columnist for SmartAsset and answers readers’ questions on personal finance topics. Do you have a question you would like answered? Email AskAnAdvisor@smartasset.com and your question may be answered in a future column.
Please note that Susannah does not participate in the SmartAdvisor Match platform and is an employee of SmartAsset.
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