Updated February 6, 2025
Here’s a fact for you: Most are worried about their retirement income. Inflation and the bear market forced millions of retirees back into the workforce, and it served as a wake up call for those of us working toward our retirement years.
With longer life expectancies and rising living costs, it’s more essential than ever to make smart decisions about retirement planning. Economic uncertainties add to the need for a stable, tax-efficient income strategy.
Having diverse financial strategies can make a huge difference in retirement comfort, so it’s essential to explore all your options.
I’ve seen a lot of people considering a Roth Conversion and I want to talk about how that helps, and make sure you’re also aware of its alternative. First, let’s start with the basics:
What Is a Roth IRA Conversion?
A Roth IRA conversion is a process of moving money from a traditional retirement account like a 401(k), SEP, or other tax-deferred retirement accounts into a Roth IRA account. It allows you to diversify tax treatments across accounts, helping to mitigate tax liabilities over time.
On the surface, this process can be beneficial for those expecting tax rates to rise or whose income is currently in a lower tax bracket. Converting now can potentially save on taxes long-term if rates increase later.
Why Do People Use a ROTH IRA?
The flexibility of Roth IRAs makes them an attractive option for individuals who want more control over their income sources in retirement. With Roth IRAs, retirees can better manage their income and minimize taxable withdrawals, providing more financial freedom in retirement.
Many people are trying to retire earlier than in the past. The ability to access the funds in the account without penalty prior to age 59 ½ is more important now.
Being able to access these funds early offers a safeguard for unexpected life events or health issues, and makes it easier to fund an active lifestyle during earlier retirement years.
Withdrawals from a traditional IRA before age 59 1/2 are subject to a 10% penalty in addition to ordinary income taxes, but withdrawals from a Roth IRA can be made penalty-free at any time.
Another reason people are converting to ROTH IRAs is to avoid paying taxes during retirement.
The impact of taxes can be more significant than many realize. Over time, these payments reduce the purchasing power of your retirement savings, making it challenging to maintain a desired lifestyle.
Rather, you can pay taxes on your savings accounts now, and convert what’s left into a ROTH IRA. This way, you don’t have to pay higher taxes during retirement.
Why don’t you want to pay taxes in retirement?
Well, even if you intend to withdraw an income small enough to be in the lowest tax bracket, you’ll still be paying 12%+ on your withdrawals.
Remember: When these traditional retirement plans were invented decades ago, the goal was to avoid paying taxes in the present, with the expectation that taxes would be lower during retirement.
However, the changing tax landscape and longer retirement horizons are leading many to reconsider this approach. Avoiding future taxes may now be preferable for today’s retirees.
Historical data has shown us that many people end up paying an exorbitant amount in taxes during retirement and the rates certainly aren’t going down. Ever considered how high tax rates could be in the future?
What is a ROTH Conversion Alternative?
This alternative approach offers a flexible, strategic way to handle tax payments without immediately reducing your retirement savings.
A Roth Conversion Alternative enables you to retain more of the value in your retirement plan and finance the taxes, leaving your whole nest egg intact. Keeping more of your income by strategically paying these taxes means you stretch your savings much further, allowing for a more comfortable retirement.
For example, if you have an effective tax rate of 24%, and you convert $100,000 from your 401k to a ROTH, you will owe $24,000 in taxes.
That leaves only $76,000 in the ROTH IRA.
The Roth Conversion Alternative approaches this in a different way. Rather than paying the taxes out of your nest egg, we partner with a lender to pay them instead.
By financing the tax payment, you maintain a higher retirement account balance, potentially resulting in greater compounded growth within your Roth IRA.
You may be wondering: why take out a loan when I have the funds now? The answer is very simple:
The interest earned on your full $100k investment offsets the interest expense on the loan to cover your taxes.
Keeping your retirement savings intact while managing tax responsibilities can be a critical factor for many individuals nearing retirement age. By preserving more of your initial investment, you have the opportunity to benefit from potential growth on a larger balance over time.
Using a Roth conversion alternative means your retirement balance works more efficiently, leveraging the tax-saving advantages of the Roth IRA without immediately reducing your assets.
The details of how this works varies client by client, and we have proprietary modeling tools to show you exactly how it works specifically - using your savings figures and retirement goals.
This strategy can be particularly advantageous for high-net-worth individuals who want to maximize their portfolio’s growth potential. Determine whether a Roth Conversion Alternative is beneficial for your unique financial situation and retirement objectives by trying our complimentary tax calculator here.
Conclusion
Paying taxes out of pocket is always a tough pill to swallow. A Roth Conversion Alternative enables you to finance the tax, leaving your whole nest egg intact.
This method allows you to preserve and grow more of your assets, providing a more robust financial base for your retirement years. Reducing tax liabilities plays a major role in achieving this.
A Roth Conversion Alternative provides greater access to convert into a tax-free account.
If you’d like to learn about how a Roth Conversion Alternative works specifically within your portfolio, feel free to contact us for a custom model.
Taking action now could offer substantial benefits, including tax savings and improved financial security throughout your retirement.
You can email me directly at jeff@enhancedfunding.com or call 773-318-9608.
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