Everyone's tax eligibility is different, but in which tax bracket is it beneficial to convert your 401(k) to a Roth 401(k) and start paying taxes in advance? For example, I am 42 years old, my wife and I have a combined income of $560,000, and we are in the 35% federal tax bracket.
Together, we have $2.6 million in retirement savings ($2.5 million of which is in traditional 401(k)/403(b) accounts). Assuming we both retire at age 67, does it make sense to convert $2.5M into a Roth account and pay taxes in the next 5-10 years versus 25 years from now?
- Gary
You are correct that everyone's tax situation is different. That's why we draw the line at certain tax brackets and say, “This is where Roth conversions make sense!” can't say. However, we can say Roth transformation It makes sense if you're currently in a lower bracket than expected pension. I'll give you some things to consider when considering whether or not you're in this situation. This will help you determine the tax bracket in which a Roth conversion will benefit you.
If you need help with retirement planning, tax strategy, or any other area of finance, consider speaking with him. financial advisor.
Tax brackets play an important role in whether tax-deferred retirement savings can be converted to a Roth account.
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As the analysis aims to compare your current and future tax rates. You are in a higher bracket based on current tax laws. This in itself suggests that a Roth conversion is unlikely to make sense to you, but it's not the whole story.
Fortunately, your current determination tax bracket It is very simple because it is a known value at any point in time. For example, here you know that the federal closing margin is 35%.
Sometimes it's not so simple, like when your income changes significantly from year to year. If this is the case, I usually recommend holding off on the analysis until the end of the year. Compared to January, there is less guesswork involved in calculating income in November, so annual estimates are more accurate.
As you say, it's important to consider your state's income tax rate if this applies to you.
This part is a little tricky and vague, especially if you're decades away from retirement. You'll have to estimate your future closings against the backdrop of uncertainty from decades of planning. Your occupation, income, and tax laws may change over time. You can't be sure how your investments will perform (and therefore how big your retirement nest egg will grow). However, with a reasonable guess, your analysis will still be helpful.
One option is to calculate your desired income if you retired today. Next, consider the tax portion of your income based on current tax laws. If this tax rate is higher than your current rate, the conversion makes more sense. If this rate is low, the conversion is meaningless.
(If you need help analyzing your tax situation and planning for the future, consider contact a financial advisor Talk about it.)
Here are some things to keep in mind as you go through the process:
Tax laws may change. As of today Tax Cuts and Jobs Act is valid. However, the relevant parts are scheduled to be completed in 2025. For example, the tax bracket and standard deduction will return to pre-2018 levels (adjusted for inflation). Congress may also pass new laws that change things over the next 25 years. Unfortunately, you have to make some assumptions about what future tax rates will be.
Are you planning to retire? Some states have no state income tax. If you're planning to retire, consider the state's income tax rate when calculating your future rates.
Not all income is taxed equally. Consider this for retirement Social Security provides tax reliefand at most only 85% of your allowance is taxable income.
End of year deadline. Unlike contributions that can be made by the tax filing deadline, Roth conversions must be completed by December 31st to file for the current year.
Pay attention to the marginal tax rate. Your marginal tax rate is higher than yours effective rateis the appropriate rate to consider. This is the tax bracket that your next taxable dollar will fall into.
(If you need more help making informed decisions based on these considerations, consider work with a financial advisor.)
Couples in their 40s review their retirement accounts and consider several Roth conversions.
In addition to the potential tax benefits of Roth conversions, Roth accounts give you more control and flexibility in your retirement.
For example, withdrawals from a Roth are tax-free, so they won't affect your Social Security benefits or taxes. Medicare IRMAA copayment. And there is none minimum distribution required (RMDs) are related to Roth accounts, which means you don't have to start withdrawing money at a certain age. RMDs add to your taxable income and may push you into the marginal tax bracket.
Finally, Roth accounts have estate planning advantages because they can be passed on to heirs tax-free.
Depending on how important these are to you, your analysis may be skewed somewhat. In other words, if you're currently in the 35% bracket but expect to be in the 32% tax bracket in retirement, it's worth considering whether this extra control and flexibility is worth the 3%. The purchase will be worth it to some, but not to others. (If you need help with financial advice, this free tool (You can contact up to three financial advisors in your area.)
To determine whether a Roth conversion is beneficial to you and which tax bracket is most affected, start by determining your current tax rate. Then, based on your assumptions, calculate your future rate and compare it to what you're currently paying. A Roth conversion makes the most sense if your current marginal tax rate is lower than what you expect in retirement.
One way is to convert assets during market downturns Lower tax on Roth conversionssince the taxable amount is based on the value of the asset at the time of conversion. When the market recovers, Roth account earnings will be tax-free, increasing conversion efficiency.
A financial advisor can help you evaluate whether a Roth conversion is right for you, and when and how to do the conversion. Looking for a financial advisor doesn't have to be difficult. Free tool from SmartAsset You will be matched with up to three financial advisors People who serve your area, and you can meet with our advisors for free and decide which one is right for you. If you're ready to find an advisor to help you achieve your financial goals, start now.
Keep an emergency fund handy in case of unexpected expenses. An emergency fund should be liquid in an account that is not subject to significant volatility like the stock market. Inflation can reduce the value of liquid cash. But high-interest accounts allow you to earn compound interest. Compare the savings accounts of these banks.
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