Fortune 500 employees and retirees have a thriving retirement plan contingent on minimizing taxes. The less you spend on taxes, the more you'll have to live out your ideal retirement. When the majority of your Fortune 500 retirement savings have been accumulated in pre-tax accounts such as your 401(k) or Traditional IRA, minimizing taxes can be difficult.
Having multiple sources of withdrawable income, including after-tax sources such as a Roth IRA, can help you minimize your Fortune 500-related tax burden in retirement. This would prevent you from having to withdraw an excessive amount from pretax sources, which could result in hefty tax invoices. The difficulty is that the IRS imposes income restrictions on Roth IRA contributors. Unless you use a Roth rollover, you cannot contribute to a Roth IRA if your Modified Adjusted Gross Income (MAGI) is above a certain threshold.
A Roth rollover or conversion allows you to take advantage of a Roth IRA and its numerous tax advantages regardless of your income. Although this can be an excellent Fortune 500 retirement planning strategy, it is not ideal for everyone. And once a Roth conversion is completed, it is irreversible! Before attempting a Roth conversion on your own, you should educate yourself on the advantages and disadvantages.
This eBook was designed to assist Fortune 500 employees and retirees navigate the Roth conversion process and determine if it's the right move for them. Schedule an obligation-free consultation with our financial team for more information. Our specialized financial advisors would be delighted to meet with you to discuss your options.
If you have any concerns, please contact the Fortune 500 Human Resources Department.
A Roth IRA rollover, also known as a Roth conversion, involves the transfer of funds from a pretax retirement account, such as a Traditional IRA or 401(k), to a Roth IRA. You pay taxes on the converted funds in the year of the rollover, but then retain them in your Roth IRA, where they can grow tax-free.
Due to the fact that Roth IRAs are not subject to Required Minimum Distributions (RMDs) and Roth distributions are not taxable, Roth conversions can help Fortune 500 retirees minimize taxes. People with large Traditional IRA or retirement account balances who do not want to face large tax obligations in retirement can benefit greatly from these strategies. Similarly, if you anticipate being in a higher tax bracket in the future, you can use a Roth conversion to pay taxes on your pre-tax savings now.
Experience with Fortune 500 employees and retirees has taught us that an overview of Roth conversions can be beneficial. Roth conversions are a reasonably straightforward procedure. You begin by funding a Traditional IRA or 401(k). Due to the fact that these accounts are funded with pre-tax dollars, you can deduct the amount you contribute. However, because Roth IRAs are post-tax accounts, you will be required to pay taxes on the rolled-over funds. Depending on the amount of your rollover and whether you've already claimed a deduction for your traditional contributions, this could result in a significant tax liability for the year.
Any amount rolled over from a Traditional IRA or 401(k) to a Roth IRA must be reported as income on your New Jersey state tax return in the same year you withdraw the funds from the Traditional IRA.
The easiest method to convert a traditional IRA to a Roth IRA is through a direct rollover. Simply inform your financial advisor that you wish to transfer the funds from your Traditional IRA to a Roth IRA with the same or a different provider. During the conversion procedure, you will establish a Roth IRA if you do not already have one. This has proven to be a popular option for many Fortune 500 clients.
Also possible is an indirect transfer utilizing the 60-day rollover procedure. In this case, you would receive a distribution check from the Traditional IRA and have 60 days to deposit the funds into your Roth IRA. Converting assets from a 401(k) or other Fortune 500-sponsored plan can be more difficult. In general, you will need to wait until you depart Fortune 500 to access the funds in your Fortune 500-sponsored plan; however, certain employers permit "in-service distributions."
To initiate the Roth conversion, you must contact the Fortune 500 plan manager directly. Inform Fortune 500 that you wish to transfer the assets directly to the financial institution holding your Roth IRA. If your Fortune 500 plan sends you a check, 20% of the balance will be withheld to satisfy distribution taxes. You will then have sixty days to deposit the funds, along with the 20 percent withheld, into your Roth IRA. If you are under 59-1/2 years old and fail this deadline, you may owe a 10 percent early withdrawal penalty.
Once the conversion is complete, the assets must typically remain in the Roth IRA for five years to avoid penalties and taxation. After meeting the five-year requirement, distributions from a Roth IRA are tax- and penalty-free if you are at least 59 1/2 years old. If you are younger than this, you can access your contributions tax- and penalty-free after five years, but any earnings you withdraw will be taxed and subject to penalties.
Note that you must accept your RMD prior to converting to a Roth IRA. Additionally, you cannot convert an RMD to a Roth. In general, the IRS limits you to one rollover per year. During this time, you cannot make a rollover from the recipient IRA.
If you have any concerns, please contact the Fortune 500 Human Resources Department.
Real World Example
The true benefit of a Roth conversion is the compounding effect. For a numerical illustration of this, consider "Linda." Linda* has a $500,000 annual income and a $700,000 Traditional IRA. She is in the 22 percent federal tax bracket and the 5.525% New Jersey state tax bracket.
Linda determines to convert $25,000 annually from her IRA in order to remain in the same federal and state tax brackets as she begins taking RMDs. After paying taxes on her conversion, she is able to contribute approximately $18,000 to her Roth IRA. If she does this every year for 15 years and earns a 7 percent annual return, she will have more than $545,000 in her Roth IRA in 15 years. This is money she can now withdraw tax-free at any time or bequeath to her heirs.
This allowed her to reduce her RMDs by more than $136,000 during that time period.[6-9]
Roth rollovers can provide Fortune 500 employees and retirees with numerous benefits, including:
TAX-FREE WITHDRAWALS: After the five-year rule has been met, you can withdraw tax-free funds from your Roth IRA. As a result, Roth IRAs are effective long-term savings vehicles, as earnings grow tax-free. In contrast, traditional retirement account distributions are taxed at conventional income rates.
WITHDRAWS AT ANY TIME: Since you have already paid taxes on your Roth contributions, you can withdraw them at any time after the five-year holding period has passed. However, the longer the funds remain in the account, the greater their tax-free growth potential. Note that if you withdraw investment earnings prior to age 59 12 you will owe ordinary income taxes plus a 10% penalty on that amount.
Given the numerous benefits of a Roth rollover, one might question why anyone would not want to perform one. However, there are disadvantages to this strategy as well.
The cost is the primary disadvantage of Roth rollovers. You must pay taxes on any quantity that you convert. This could result in a hefty tax charge if you make a substantial rollover or are in a high tax bracket at the time of conversion. If you convert a substantial quantity, you run the risk of falling into a higher tax bracket, which would increase your bill even further.
Fortune 500 withholds 20% of the amount you request if you elect to use a portion of the converted balance to pay taxes, just as it does when you withdraw funds from your 401(k). This strategy will reduce the amount of money you invest in a Roth IRA in order to benefit from tax-free growth. If you convert your 401(k) before turning 59-1/2 years old, you may be subject to a 10% early withdrawal penalty in addition to the taxes you'll already owe.
The five-year rule is an additional drawback of Roth conversions. To avoid taxes and a possible penalty when withdrawing converted funds from a Roth IRA, you must wait at least five years. If you believe you will need the money before the five-year anniversary of your conversion, you may not want to invest it in a new Roth.
Another important aspect to consider when utilizing Roth rollovers as a Fortune 500 employee or retiree is the potential impact on your Medicare premiums. Roth conversions can increase your Modified Adjusted Gross Income (MAGI), which is used to determine your Medicare Part B and Part D premiums. As reported by the Social Security Administration, individuals with higher MAGI may be subject to income-related monthly adjustment amounts (IRMAA), resulting in higher Medicare premiums. It's essential to evaluate the potential impact on your overall retirement income and healthcare costs when deciding to proceed with a Roth conversion.
If you have any concerns, please contact the Fortune 500 Human Resources Department.
The Roth conversion option is not available to all Fortune 500 employees and retirees. Here are some instances in which you should not transfer over your Roth IRA:
YOU’LL BE IN A LOWER TAX BRACKET IN RETIREMENT: In retirement, your tax bracket will be lower. Typically, the purpose of a Roth conversion is to reduce taxes, so it makes little sense to convert if you anticipate being in a lower tax bracket in the future. New Jersey is not considered a tax-friendly state, so if you intend to retire in a state with a lower tax rate, such as Florida or Virginia, you may be better off delaying your conversion until then.
YOU CAN’T PAY THE CONVERSION TAXES: Roth conversions will increase your tax liability in the year of conversion. If you lack the funds to pay this account immediately, you should likely avoid the conversion. As discussed previously, using a portion of the rollover to pay your tax obligation negates the tax-saving advantages of the rollover.
THE ROLLOVER WILL RAISE YOUR TAX BRACKET: Due to the fact that Roth conversions are reported as income on your New Jersey and federal tax returns, they can cause you to fall into a higher marginal tax bracket. If this is a concern, you may wish to spread out the conversion over several years.
YOU’LL NEED THE MONEY IN LESS THAN FIVE YEARS: If you believe you will need the money you intend to convert in less than five years, there is likely no point in converting it, as you will end up paying taxes anyway.
Imagine you're a gardener tending to a beautiful garden. You have different types of plants, each requiring specific care and attention. Some plants thrive in the sunlight, while others prefer the shade. In your garden, you have both traditional plants and special plants called "Roth plants." The traditional plants represent your pre-tax retirement savings, and the Roth plants represent your after-tax savings. By strategically placing the Roth plants in the sun, you ensure they grow and flourish tax-free. This allows you to enjoy the fruits of your labor without the burden of taxes. With Roth rollovers, you have the power to cultivate a garden where you keep more of what you own, protecting your retirement income from unnecessary taxes and maximizing your financial harvest.
Roth conversions are ultimately personal decisions. Since each individual's circumstances are unique, the decision to convert or not must be made on a case-by-case basis.
Consult a financial advisor if you are still uncertain whether a Roth rollover is appropriate for you. At The Retirement Group, we can assess both the current and prospective tax implications of a Roth conversion. There's always next year if the figures don't work out this year.
The Retirement Group is a nation-wide group of financial advisors who work together as a team.
We focus entirely on retirement planning and the design of retirement portfolios for transitioning corporate employees. Each representative of the group has been hand selected by The Retirement Group in select cities of the United States. Each advisor was selected based on their pension expertise, experience in financial planning, and portfolio construction knowledge.
TRG takes a teamwork approach in providing the best possible solutions for our clients’ concerns. The Team has a conservative investment philosophy and diversifies client portfolios with laddered bonds, CDs, mutual funds, ETFs, Annuities, Stocks and other investments to help achieve their goals. The team addresses Retirement, Pension, Tax, Asset Allocation, Estate, and Elder Care issues. This document utilizes various research tools and techniques. A variety of assumptions and judgmental elements are inevitably inherent in any attempt to estimate future results and, consequently, such results should be viewed as tentative estimations. Changes in the law, investment climate, interest rates, and personal circumstances will have profound effects on both the accuracy of our estimations and the suitability of our recommendations. The need for ongoing sensitivity to change and for constant re-examination and alteration of the plan is thus apparent.
Therefore, we encourage you to have your plan updated a few months before your potential retirement date as well as an annual review. It should be emphasized that neither The Retirement Group, LLC nor any of its employees can engage in the practice of law or accounting and that nothing in this document should be taken as an effort to do so. We look forward to working with tax and/or legal professionals you may select to discuss the relevant ramifications of our recommendations.
Throughout your retirement years we will continue to update you on issues affecting your retirement through our complimentary and proprietary newsletters, workshops and regular updates. You may always reach us at (800) 900-5867.
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