15 Common Roth Conversion and Savings Mistakes People Make

It’s very likely that you’ve considered saving (or converting existing savings) to a Roth IRA or 401k. Maybe someone, a friend, family member, advisor, your bank, or a colleague recommended it to you. And, you’ve probably seen, if not read, an article about Roth benefits.

All retirement savings accounts are designed to help you save money on taxes. And, Roths can be a great way to reduce your tax burden.

What is Roth?: A Roth is a retirement savings account. With a Roth, you pay taxes on the money you contribute to the account. The trade-offs (and the reason they’re so popular) are that your money is tax-free, withdrawals aren’t taxed, and you need to take minimum distributions at a certain age. do not have. (Learn more about Roth benefits.)

(With a traditional 401k or IRA, your savings contributions are tax-deferred. You don’t pay taxes on your savings.)

Roths can be fantastic, but aren’t always for everyone and can have significant pitfalls. Below are 15 mistakes to avoid with Roth accounts.

1. Not opening a Roth because you already have a 401(k).

There are two main types of retirement savings accounts: IRAs (traditional and Roth) and employer-sponsored retirement accounts such as 401ks (traditional and Roth), SEPs, 403bs, etc.

If you’re saving in a retirement plan at work, you’re still allowed to save in an IRA or Roth IRA and, if you have the cash flow, you probably should.

You are allowed to contribute to both a Roth IRA and your employer-sponsored retirement plan.

Contribution limits to IRAs (Roth and traditional) for 2024 are $7,000 and an additional $1,000 in catch-up contributions if you’re age 50 or older.

The 401k annual contribution limit is $23,000 for 2024, and there’s a $7,500 catch-up contribution if you’re 50 or older.

2. Not taking advantage of a Roth because you make a lot of money.

It’s true, there are income limits when it comes to contributing to a Roth account. In 2024, you can only save in a Roth if your modified adjusted gross income (MAGI) is below a certain threshold. Check the latest. Income limit Set by the IRS.

However, income limits should not discourage you from taking advantage of Roth accounts. While you can’t save directly into a Roth, you can save into a traditional IRA and convert those funds into a Roth. This is often called a “backdoor” Roth savings.

Learn more about Backdoor Roth.

3. Converting money to a Roth without following the rules

When converting money from a traditional retirement savings vehicle to a Roth, you need to follow the conversion rules. You can either:

  • Rollover: A rollover is when you take distributions from your traditional IRA and are sure to deposit the money into a Roth account within 60 days.
  • Trustee to Trustee Transfer: This is where you instruct the institution that holds your traditional IRA to transfer the funds to another institution where you have a Roth account.
  • Transfer of a single trustee: In this case, both your traditional and Roth accounts are with the same institution, and you direct them to transfer.

If you simply withdraw funds from your retirement plan and put them into a Roth IRA, you may be subject to a 10% early distribution tax.

4. Withdrawing converted Roth funds too early

The beauty of a Roth is that the funds grow tax-free. So, in general, you want time for the account to grow after a Roth conversion.

More specifically and importantly, it is very important to know that the converted Roth funds must remain in your Roth IRA for at least 5 years before withdrawal.

For withdrawal before 5 years, there will be 10% early withdrawal penalty.

5. Contributing too much to a Roth

As noted above, there are limits to how much you can contribute to a Roth. The IRS will charge you a 6% penalty tax on any investments that are over the limit. The penalty is assessed for each year that you have not taken action to correct the error.

6. Cash flow is not available to pay taxes on a Roth conversion.

Unlike contribution limits, there is no limit to how much you can convert into a Roth. However, you must be able to pay the tax due on the conversion.

Your change may be limited by how much tax you can afford in any given year.

The converted funds will be treated as income by the IRS and taxed as such.

7. Improper planning of when to convert

Timing when to do a Roth conversion is tricky.

What can be complicated is timing how much to do and when to do it. There are several important factors to consider:

  • Your income (current and future)
  • Your tax bracket (current and future)
  • Future changes to the tax code
  • How much money you have in traditional accounts and the value of required minimum distributions (RMDs) when you reach retirement age
  • Cash is available to pay tax on conversion.
  • How much time between conversions and when you will start withdrawing funds.
  • The rate of return you will make on Roth funds.
  • Your goal for conversion: For example, do you want to reduce taxes over a lifetime? Stay below a certain tax or IRMAA threshold? Maximize the value of your property?

Trying to figure out how much and when to change can be complicated. Many people find it’s best to spread out conversions and adopt a multi-year conversion strategy.

Here are some resources to help you learn how to optimize Roth conversions:

New Retirement’s Roth Conversion Explorer

Explorer is part of New Retirement Planner Plus. This tool helps take the guesswork out of whether and when you should convert. Explorer will use your plan and run thousands of scenarios to identify personalized strategies for you to convert based on your chosen goal.

Modeling Exchanges in the New Retirement Planner

As described above, Roth Conversion Explorer suggests conversions based on the goal you select. However, you may have other Roth conversion scenarios you want to consider. You can model any potential change in New Retirement Planner and immediately see the impact on your lifetime tax costs and your incremental tax costs for the year you change. Or, evaluate it in terms of your future cash flow. How will the conversion affect your required minimum distribution? And more…

Advice from a fee-only financial advisor

How to save? How much to save? Should you change? These may seem like simple questions, but the reality is that it’s complex and working with a professional to get the right answers for you can be reassuring.

If you’re interested in a personalized Roth conversion strategy and want professional expertise, collaborate with a Certified Financial Planner™ professional at New Retirement Advisors to identify and achieve your goals. Book a free discovery session.

8. Not investing properly

Tax-free growth is the name of the Roth IRA game. As such, you want to ensure that your funds in a Roth IRA are invested for growth that is appropriate for your age and risk tolerance.

9. Using a Roth when you’re in your highest tax bracket

If you’re in your highest earning years, you’ll likely be better served with a traditional contribution than a Roth during those years.

And, if you think taxes will be lower in the future, a Roth conversion may not be for you right now.

The new retirement planner can give you insight into your tax bracket for all future years. This can help you see opportunities for Roth conversions.

10. Not modeling your future income

Many people think that their income will drop in retirement and that taxes will not be a factor.

However, this may not be true, especially if you have significant retirement savings. Required minimum distributions (RMDs) can move your income level into a higher tax bracket.

Modeling future income enables you to understand whether Roth savings or a Roth conversion is a good idea for you.

The new retirement planner enables you to model your future income and the system automatically factors your RMDs. This can help you visualize future tax brackets and liabilities.

11. Ignoring your spouse’s opportunities to save

For better or worse, often in couples one partner is more involved in the financial health of the household than the other – regardless of whether you both have income. And, sometimes this imbalance means that the financially savvy partner is making all the right moves with their money, but not necessarily taking advantage of the partner’s opportunities.

If your spouse has income, make sure they are saving in the most beneficial vehicle possible, which could be a Roth account.

12. Ignoring savings opportunities for your spouse (even if they don’t have an income).

Generally, you need earnings to save in tax-advantaged savings vehicles.

However, if you’re married and file a joint return, you can get the maximum Roth IRA for each spouse by using a spousal IRA. You can contribute on their behalf and the annual individual contribution limits are the same.

So, if you’re married, both over 50, file a joint return, and only one spouse has income, you can still contribute up to $16,000 toward your home. ($7,000 plus an additional $1,000 in catch-up contributions for each of you.)

13. You think you’re too old or too young to contribute to a Roth.

There is no age restriction for contributing or converting funds to a Roth IRA.

The main factor to consider is your tax liability for one type of savings vehicle or the other.

14. Names of beneficiaries and non-updation

This is not necessarily specific to Roth accounts, but not updating beneficiary names for accounts is a mistake that is often made. And, this is very relevant to Roth accounts.

Not having a beneficiary or having the wrong beneficiary can seriously derail your estate plan.

15. Not considering Roth savings and conversions in light of a comprehensive financial plan

No financial decision should ever be made without understanding the pros and cons of your current and future overall financial picture.

There are many considerations that will affect the actual benefit (or downside) of making the change. For example, your family and potential inheritance may be affected by whether or not your savings are in a Roth.

Maintaining a comprehensive written financial plan is a great way to model the impact of your decisions.

New Retirement Planner is the most comprehensive tool available online. The easy-to-use system helps you make better decisions, enjoy better financial results, and experience more peace of mind about your money.

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