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I’m 44 and have $1 million in retirement savings. I want a backdoor Roth IRA, but I don’t know where to start

Financial advisor and columnist Michele Cagan

I’m 44 and have $1 million in my 401(k), IRA and Roth IRA. Since my total household is above the threshold for investing in a Roth IRA, I am considering using the backdoor Roth IRA tactics. I left $700,000 in a 401(k) with my old employer. I’m trying to come up with a strategy to “distribute” the old 401(k) balance into a traditional IRA while not going out of my current tax bracket and pair that with a subsequent Roth conversion, but I don’t know how to begin . First, is there a cap on how much I can convert using a backdoor Roth (ideally an amount that doesn’t push you into the next tax bracket)? Should I open a new set of traditional and Roth IRAs since I currently have both? I get a good monthly pension and a decent Social Security benefit (totaling $70,000 in 2045), so I think converting most if not all of my 401(k) to a backdoor Roth is a good financial move, from it assuming I maintain good health. Any advice?

– The tax hater

Converting traditional retirement accounts to Roth IRAs can save you a lot of money in taxes in the long run. But at the time of conversion you will have to pay a large tax bill. There’s no limit to how much you can convert at once or how many conversions you can make in a year, but with large balances like the one you have, you might want to take it a little easier. You can minimize your tax burden by strategically spreading your conversions over multiple tax years and possibly tapping into other tax-saving strategies. The rules and calculations can be tricky, so it’s best to work with an experienced tax professional to keep taxes manageable.

Can a financial advisor help you complete a backdoor Roth conversion and answer other retirement-related questions? Contact a financial advisor today.

Benefits of Roth IRAs

Roth IRAs have several tax benefits to consider. Roth IRAs have several tax benefits to consider.

Roth IRAs have several tax benefits to consider.

Roth IRAs offer a number of tax benefits. Because they are funded with after-tax dollars, you don’t get a tax break now. However, they offer completely tax-free withdrawals, including account earnings. That means you benefit from potentially decades of growth without ever having to pay taxes on it.

Another big benefit: Roth IRAs are not subject to required minimum distributions (RMDs). That means you don’t have to withdraw money if you don’t want to, giving your money even more time to grow tax-free. It also gives your heirs access to more tax-free funds in the future.

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Finally, you can contribute to Roth IRAs no matter how old you are, as long as you have qualifying income. (And if you need help deciding how to divide your savings between Roth and tax-deferred accounts, consider talking to a financial advisor.)

Contributing to a Roth IRA is subject to annual income limits: If your income is greater than $161,000 in 2024 and you file single, you are not eligible to contribute to a Roth IRA. However, you can contribute to a traditional IRA or 401(k) and then perform a Roth conversion through a legal loophole known as the backdoor Roth IRA.

3 reasons to get out of old employers’ retirement accounts

While most people have the option to keep their employer-based retirement accounts intact even after they leave that job, it’s often better to roll over those accounts to IRAs. Taking that step can benefit you in three important ways:

  1. More investment opportunities: Most employer plans have a fairly limited range of investment options. With an IRA, you have access to a whole world of securities that can make it easier to achieve your financial goals.

  2. Lower costs: Employer-based retirement plans come with a lot of costs that you don’t necessarily see. These may include plan management fees, investment management fees, service fees and administrative fees. Whatever they’re called, they can add up and eat away at your account balance. Many institutions offer free IRAs, which takes the heavy burden off your contributions and earnings.

  3. More control: When you convert an employer plan to an IRA, you can make any choice, from the brokerage that manages your account to the mix of investments you hold. It can be easier to find and access information. Additionally, many brokers offer additional incentives such as free funds and trades.

While it may seem like a hassle, it’s actually very easy to convert your 401(k) to an IRA or convert it to a Roth IRA. (Note that a financial advisor can help you with rollovers, conversions, and managing your retirement savings.)

How to do a Roth conversion

The mechanics of a Roth conversion are quite simple. You contact the trustee or manager of the traditional account you want to withdraw money from and let them know you want to do a Roth conversion. Sometimes you have a choice of conversion method, sometimes you don’t. The three basic options include:

  1. A trustee-to-trustee transfer, or direct rollover, where you tell the financial institution that houses your traditional 401(k) or IRA to transfer the money directly to your account at another institution. Once in your new IRA, you can convert it to a Roth account.

  2. An internal trustee transfer (also called same trustee), where you tell the institution that houses your traditional 401(k) or IRA to transfer the money directly to your Roth account within the same institution.

  3. An indirect rollover, where you take a distribution from your traditional 401(k) or IRA as a check and then deposit the full amount into your new account within 60 days. From there, you can convert your new IRA into a Roth account.

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Whenever possible, avoid the indirect rollover method. If you do not complete the deposit within the 60-day period, the IRS will treat it as a taxable distribution subject to income tax and a 10% early withdrawal penalty (unless you are at least 59.5 years old).

Whichever method you use, you report the conversion on IRS Form 8606 when you file your tax return. (A financial advisor can help you manage your IRAs and select investments that align with your retirement timeline.)

Effective Strategies for Roth Conversions

A woman is looking at her retirement accounts and considering a Roth conversion. A woman is looking at her retirement accounts and considering a Roth conversion.

A woman is looking at her retirement accounts and considering a Roth conversion.

There are a few things you can do to keep Roth conversion taxes to a minimum.

First, you can time the conversion for when the current value of your retirement account has declined due to market conditions. The lower value leads to a lower tax assessment on the conversion.

Second, you can convert all or part of your retirement account in a year when your income is lower than normal. This places you in a lower tax bracket, which reduces your overall tax bill.

Finally, and usually the most economical method, is to spread the conversion over several years. This offers you the most flexibility and reduces the chance that you will end up in a higher tax bracket when converting.

Here’s how it can work:

Let’s say you have $500,000 in a 401(k). You file your taxes as a single person and your other taxable income is $120,000, which puts you in the 24% tax bracket. If you were to convert the entire $500,000 in 2024, your taxable income would increase to $620,000. That would put you in the 37% category, which would affect a lot of the conversion.

Instead, you can do a partial conversion. The 24% tax bracket will be $191,950 in 2024 for individual filers. So you can convert up to $71,950 without falling into the 32% tax bracket. If you want to do more than that, you can convert up to $123,725 at the 32% rate without falling into the 35% bracket.

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By combining these methods with an emphasis on the third, you can minimize the overall total tax burden of the conversion. (But if you need additional guidance on completing a Roth conversion, SmartAsset’s free tool can help you connect with a fiduciary financial advisor.)

Understand the five-year rule

Before converting your retirement savings into a Roth IRA, it’s important to understand the five-year rule for Roth conversions.

Converted funds (as opposed to contributed funds) must remain in the Roth IRA for five years before you can withdraw them. If you withdraw funds before then, you may incur a 10% early withdrawal penalty. The five-year timeline starts on January 1 of the year you made the conversion. For example, if you convert $50,000 into a Roth IRA in September 2024, the clock starts on January 1, 2024 and runs until January 1, 2029.

This rule applies to each conversion separately. So if you make a series of conversions to minimize their tax consequences, the five-year clock for each conversion starts in the year it was made. (A financial advisor can help you follow the various rules, including the five-year rule, when doing a Roth conversion.)

In short

If you’ve decided to convert traditional retirement accounts to a Roth IRA, take proactive steps to minimize the tax bill so you can keep more of your money. You’ll pay less tax now and no tax later if you eventually start making qualified withdrawals from the account later.

Retirement planning tips

  • Required minimum distributions (RMDs) can throw your retirement plan into disarray. These mandatory withdrawals from deferred retirement accounts begin at age 73, increasing your tax liability and potentially pushing your income into a higher marginal tax bracket. That’s why planning ahead is crucial. SmartAsset’s RMD calculator can help you estimate how much your first RMD will be and when it is due.

  • Whether you’re interested in a backdoor Roth conversion or want to reduce your tax liability in retirement, working with a financial advisor can help you plan for your golden years. Finding a financial advisor does not have to be difficult. SmartAsset’s free tool matches you with up to three vetted financial advisors serving your area, and you can have a free introductory meeting with your advisors to decide which one you think is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.

Michele Cagan, CPA, is a financial planning columnist at SmartAsset, answering reader questions about personal finance and tax topics. Do you have a question that you would like answered? Email AskAnAdvisor@smartasset.cand your question may be answered in a future column. The question may be edited for length or clarity

Please note that Michele is not a participant in SmartAsset AMP.

Photo credit: ©iStock.com/Kameleon007, ©iStock.com/Luke Chan

The post Ask an Advisor: I’m 44 and have $1 million in retirement savings. I Want a Backdoor Roth IRA, But I Don’t Know Where to Start appeared first on SmartReads from SmartAsset.

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