One of the costs of converting a traditional IRA to a Roth IRA is how much you will pay in taxes. In some cases, those taxes can be a heavy burden, especially if you have been diligent in building up the balance in your traditional IRA. Fortunately there’s a way to put a lid on your tax liability as you convert to a Roth. Rather than converting the entire traditional IRA all at once, you could do a series of partial conversions. Consider working with a financial advisor to help ensure that you are handling your tax-advantaged accounts in the smartest way.
Roth Conversion Basics
There are two key reasons to convert a traditional IRA to a Roth IRA. One is that you can withdraw money later tax free, and second is that there are no required minimum distributions. Remember that early withdrawals (before age 59.5) from a traditional IRA are subject to a 10% penalty. When you convert from a traditional IRA to a Roth you’ll want to make sure you do so in a way that doesn’t trigger the penalty. You have 60 days to convert if you move the money. It’s generally safer to let your brokerage(s) handle the conversion so you don’t forget to make the 60-day deadline.
Keep in mind that money in your traditional IRA has yet to be taxed. The point of a Roth IRA is that it’s already taxed money that grows tax-free. So, to convert your traditional IRA to a Roth IRA you’ll have to pay ordinary income taxes on your traditional IRA contributions in the year of the conversion before they “count” as Roth IRA funds. The taxable amount that you convert to a Roth gets added to your taxable income for that year and is taxed at the appropriate rate.
Doing Partial Roth Conversions
Just as dollar-cost averaging helps ensure that you’re not buying high and selling low, a common mistake some retail investors make – doing a series of partial Roth conversions can help put a lid on what you will owe the government in taxes, according to Morningstar. The point is to convert just enough each year to keep you from being bumped up into a higher tax bracket.
For example, in 2022 a married couple earning up to $178,150 would be in the 22% tax bracket. But this couple would be in the 24% tax bracket if their total taxable income was from $178,151 to $340,100. Now, suppose that in 2022 they have taxable income of $125,000; a 22% tax rate on that amount is $27,500. If they convert a traditional IRA with a $115,000 balance to a Roth, that would result in their taxable income rising from $125,000 to $240,000. That puts them in a 24% tax bracket, and 24% of $240,000 is $57,600.
Now, however, suppose they decide on a partial Roth conversion. Rather than convert the entire $115,000 traditional IRA to a Roth, they only convert $50,000. That puts their taxable income at $175,000, still within the 22% tax bracket. A 22% tax on $175,000 is $38,500 – far less than the $57,600 they would have owed if they had converted the entire traditional IRA into a Roth.
Considerations of Partial Conversions
Clearly, partial conversions of traditional IRAs to Roth IRAs, done correctly, enable you to avoid unnecessary federal taxes. But besides this obvious benefit, there are some challenges that should be factored into your decision to do a partial conversion.
For example, what are the relevant state taxes? If you’re moving into a state that has a higher tax rate you’ll need to take that into consideration as you calculate how much of your traditional IRA to convert. Secondly, what will you earn in a calendar year? That can be hard to predict, especially if your compensation depends on commissions or if you stand to receive a bonus or you plan to exercise an incentive stock option.
Finally, keep in mind that extra income from a Roth conversion can result in your losing the subsidy you are entitled to as part of the Affordable Care Act.
The primary reason to consider partial Roth conversions is to control future tax liability. You do this by “filling up” your current tax bracket to cap your taxable income at the maximum level of your existing tax bracket. This is sometimes called tax bracket arbitrage, paying taxes now at a lower rate than you otherwise would have to do at a future date.
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BofA Securities maintains Amazon.com at ‘buy’ with a price target of $154.00
Six people in critical condition, one still missing after Paris blast – prosecutor
© Reuters. French firefighters and rescue forces work after several buildings on fire following a gas explosion in the fifth arrondissement of Paris, France, June 21, 2023. REUTERS/Gonzalo Fuentes
PARIS (Reuters) – Six people remained in a critical condition and one person was believed still missing on Thursday, one day after a blast ripped through a street near Paris’ historic Latin Quarter, the city’s public prosecution office said. “These figures may still change,” prosecutor Maylis De Roeck told Reuters in a text message, adding that around 50 people had been injured in the blast, which set buildings ablaze and caused the front of one to collapse onto the street. Of two people initially believed missing, one has been found in hospital and is being taken care of, the prosecutor said, adding: “Searches are ongoing to find the second person.” Authorities have not yet said what caused the explosion, which witnesses said had followed a strong smell of gas at the site. The explosion led to scenes of chaos and destruction in the historic Rue Saint Jacques, which runs from the Notre-Dame de Paris Cathedral to the Sorbonne University, just as people were heading home from work. It also destroyed the facade of a building housing the Paris American Academy design school popular with foreign students. Florence Berthout, mayor of the Paris district where the blast occurred, said 12 students who should have been in the academy’s classrooms at the time had fortunately gone to visit an exhibition with their teacher.
“Otherwise the (death toll) could have been absolutely horrific,” Berthout told BFM TV. She said three children who had been passing by at the time were among the injured, although their lives were not in danger.
4 big analyst cuts: Alcoa & DigitalOcean shares drop on downgrades
Here is your Pro Recap of the biggest analyst cuts you may have missed since yesterday: downgrades at Alcoa, DigitalOcean, Teleflex, and Xcel Energy.InvestingPro subscribers got this news in rapid fire. Never be left in the dust again.Alcoa stock drops on Morgan Stanley downgrade Alcoa (NYSE:) shares fell more than 3% pre-market today after Morgan Stanley downgraded the company to Underweight from Equalweight and cut its price target to $33.00 from $43.00, as reported in real time on InvestingPro.The firm sees a significant decline in consensus estimates, and as negative earnings revisions materialize, it believes the stock will face downward pressure and underperform.The analyst’s estimates for EBITDA in Q2, 2023, and 2024 are substantially lower than the consensus. The stock is currently trading above its historical average. The firm said its downward revisions in earnings estimates and price target are attributed to the company’s high operating leverage to aluminum prices.DigitalOcean stock plunges on downgradePiper Sandler downgraded DigitalOcean (NYSE:) to Underweight from Neutral with a price target of $35.00. As a result, shares plunged more than 5% pre-market today.The company reported its last month, with revenue beating the consensus estimate, while EPS coming in worse than expected. Furthermore, the company provided a strong outlook, which was above the Street estimates.2 more downgradesTeleflex (NYSE:) shares fell more than 3% yesterday after Needham downgraded the company to Hold from Buy, noting that UroLift expectations may still be too high.According to Needham, their checks indicate that urologists are reducing their use of UroLift due to its retreatment rates, reimbursement cuts, and increasing use of competing procedures. This is also supported by their Google Trends data analysis, which indicates decreasing search interest in UroLift.BMO Capital downgraded Xcel Energy (NASDAQ:) to Market Perform from Outperform and cut its price target to $64.00 from $69.00 to reflect the lower-than-expected terms of the company’s regulatory settlement in Colorado.Amid whipsaw markets and a slew of critical headlines, seize on the right timing to protect your profits: Always be the first to know with InvestingPro.Start your free 7-day trial now.
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