&l;p&g;&l;img class=&q;dam-image shutterstock size-large wp-image-1081674983&q; src=&q;https://specials-images.forbesimg.com/dam/imageserve/1081674983/960×0.jpg?fit=scale&q; data-height=&q;639&q; data-width=&q;960&q;&g; Shutterstock
&l;span&g;&l;em&g;This is the second blog in a two-part series that focuses on&a;nbsp;selecting an appropriate retirement account for your current financial situation and long-term goals.&l;/em&g;&l;/span&g;
For retirement savers seeking to minimize their tax bills, an individual retirement account (IRA) offers unique benefits. Indeed, taxes are an important consideration of any financial plan; if not appropriately managed, excessive tax payments can significantly erode the wealth you have worked hard to create. Fortunately, a strategic retirement savings approach can potentially lower your tax burden over the course of your lifetime and reduce eventual estate taxes.
When selecting an IRA, you may have the option of choosing between the tax-deferred benefits of a traditional IRA or the tax-free earnings potential of a Roth IRA. Traditional IRAs defer your tax payments until you begin taking distributions in retirement, while Roth IRAs are built on after-tax dollars but allow for tax-free distributions. While traditional IRAs that defer taxes can be beneficial, these plans are accompanied by eventual distribution requirements that are taxable. If paying taxes on your contributions today is not prohibitive, Roth IRAs can offer many advantages during your retirement years and beyond.
&l;strong&g;Long-Term Benefits of Roth IRAs&l;/strong&g;
High earners who are ineligible to contribute to a Roth IRA may forgo certain tax benefits if their retirement savings are exclusively in a traditional IRA. In 2018, married couples with a combined modified adjusted gross income that equals or exceeds $199,000 and single tax payers with annual income of $135,000 or more are not eligible to contribute to a Roth IRA. However, because the IRS recently removed the income cap for converting a traditional or rollover IRA to a Roth IRA, high earners are now able to reduce their future tax liabilities through a &a;ldquo;backdoor&a;rdquo; Roth.
Roth IRAs do not require the original owner to take minimum distributions like traditional IRAs do, so if you have other sources of income, assets in a Roth account may continue to grow tax-free during your lifetime. Additionally, any qualified distributions you take after the age of 59 &a;frac12;&a;mdash;or any eventual withdrawals made by your beneficiaries&a;mdash;are not taxed if the account has been held for at least five years.
If you think converting your traditional IRA to a Roth IRA may make sense for your financial planning needs, consider the following features.
&l;strong&g;Income taxes incurred upon conversion.&l;/strong&g; When you fully convert a traditional IRA to a Roth IRA, ordinary income taxes, and possibly the Medicare surtax, are due on the total amount converted in that tax year. If you have accumulated considerable wealth, removing all or a portion of your retirement assets from your taxable estate by paying income taxes today may reduce your beneficiaries&a;rsquo; future tax liability. For individuals considering this &a;ldquo;backdoor&a;rdquo; approach to opening a Roth IRA, making the conversion during a market downturn may lessen your immediate tax burden if your account balance has fallen significantly.
&l;strong&g;Distributions.&l;/strong&g; The absence of required minimum distributions (RMDs) for the original account owner is one of the key benefits of a Roth IRA. Not having to take RMDs offers additional growth potential if you prefer to pass on your assets instead of spending them in retirement. However, if you keep your traditional IRA, you will have to take RMDs beginning at age 70 &a;frac12; and pay taxes on the annual distributions. Paying taxes once following a Roth IRA conversion positions the remaining value of your retirement assets to grow tax-free until eventually needed or distributed to your heirs.
&l;strong&g;Estate planning considerations.&l;/strong&g; Traditional IRA assets that are passed to non-spousal beneficiaries, especially during peak earning years, can result in a significant tax bill for your heirs. If you anticipate having a sizable account balance when you die, converting to a Roth now may save your designated beneficiaries from paying taxes on that portion of your assets. Withdrawals made by your heirs are tax-free regardless of your age when you die or their age when they inherit the account, if the Roth IRA has existed for at least five years. Spousal beneficiaries, on the other hand, can elect to treat an inherited Roth IRA as their own, but withdrawals made prior to age 59 &a;frac12; may be subjected to taxes and additional penalties.
Once a conversion to a Roth IRA has been made, there is a five-year period during which part of your distributions may still be taxed. However, a backdoor Roth may ultimately reduce the taxes you or your designated beneficiaries must pay, if you can postpone withdrawals until the minimum waiting period has passed. A word of caution: the new tax law eliminates the ability to re-characterize or undo a Roth conversion, so be sure and consult with your tax advisor.
Depending on the length of your retirement, your other sources of retirement income, and your estate planning goals, you may not need to access the entirety of your savings to achieve a comfortable retirement. A Roth IRA allows you to continue to grow your assets tax-free through retirement and moves your tax burden to the present, so that your beneficiaries are not forced to give up a significant portion of their inheritance to taxes. If you have overlooked opening a Roth IRA as part of your retirement planning strategy because your income exceeds the IRS&a;rsquo;s limits, consider whether converting your traditional IRA to a Roth IRA may benefit you and your family in the long run.
&l;em&g;This information is not intended as tax advice. Tax information is based on federal income tax law. State and local income tax laws may differ. Please consult your tax advisor about your particular situation.&l;/em&g;