Hegna's Hotseat

The Conversion That Will Save Your Retirement


ax time is here again, which means many people are likely reviewing their tax situations and trying to see where they can optimize their taxes. Most people rely on a 401(k) plan and Social Security to fund a good portion of their retirement. However, here’s something most people don’t realize: the money you have in your 401(k) is not entirely yours. When it comes time for you to withdraw that money, the federal government will take its share in taxes and you’ll get whatever is left after that. If you rely totally on your 401(k) and Social Security for retirement income, you need to account for taxation of that income. So, to make up for what will be lost to taxes, you need to have sources of tax-free income in retirement, and a Roth IRA is a great option for that.

In my book Paychecks and Playchecks, I talked about reading John D. Bledsoe’s book The Gospel of Roth. After reading it, I immediately converted my own traditional IRA into a Roth IRA and I’ll tell you why. A traditional IRA requires you to pay taxes when you withdraw the money, so you will be paying taxes at whatever the income tax rate is in the future. With a Roth IRA, you’ll pay income taxes upfront on any contributions you make, but that money is then able to grow tax-free while it’s in the account. When you’re ready to take the money out in retirement, you also don’t have to pay taxes on any withdrawals! Tax rates are at historic lows right now, which means they will almost certainly be higher 20 or 30 years in the future. Paying taxes upfront through a Roth IRA will get you a solid source of tax-free income in retirement. Roth IRAs are also not subject to Required Minimum Distributions (RMDs) the way a traditional IRA is, so the money can grow in the account for as long as you want it to.

Converting to a Roth IRA is all about timing, though. Once you convert any money into a Roth IRA, you can’t reverse the conversion. Consulting with a financial advisor can be very helpful for figuring out when the best time is to convert your money. It’s also important to know the “five-year rule” of Roth IRAs. If you take funds out of a Roth IRA account that is less than five years old, you may have to pay taxes on some of the withdrawals. So, you have to give your money time to take advantage of taxes, but it is well worth it.

There is no way to completely avoid paying taxes on your retirement funds. With tax-deferred income like 401(k) money and traditional IRAs, you will be subject to whatever the tax rate is in the future. Locking in today’s low tax rates with a Roth IRA will prevent you from losing any of your hard-earned retirement money to taxes. If you want more strategies for optimizing your taxes, check out this documentary I was featured in called The Power of Zero.  Directed by Doug Orchard and based off of David McKnight's book, this film dives deep into ways that people can manage their taxes so they can have secure, guaranteed lifetime income in retirement. Click here for more information about the film.

See you on my next blog post,

-Tom Hegna

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