Of the three tax structures you can invest under for your long-term portfolio, the Already Taxed or Roth account is the most difficult to contribute to in a balanced manner. It’s worth spending some time with a financial advisor to go over how you can get money into your Roth by making conversions.
A conversion takes money that is already in a tax-deferred account and moves it to a Roth account.
Imagine you have $100,000 in a traditional IRA that you originally took a tax deduction to fund the IRA. If you convert that money into a Roth IRA today, at the year’s end you will receive a 1099 for $100,000 of income. That means you will pay tax as if you received $100,000 of income, even though all you did was move money from one account to another.
You’d never pay tax again on the original income, or the earnings made in future years.
However, if you have after-tax money in any traditional IRA, this method won’t work as well. It can get pretty complicated, so you should meet with a financial advisor before proceeding. In short, don’t consider doing a conversion if you have after-tax money in an IRA.
Some employers allow you to overfund your 401k and put in more than the deductible limit. You won’t get a tax deduction for those contributions, and your employer can immediately convert that money into Roth within your 401k. No tax is owed because you’re putting in after-tax money and immediately converting it to Roth.
What you need to have in place before making conversions.
Check out your available options with your employer, but remember that you won’t have access to this money until retirement, so have a plan in place to meet your expenses until then.
Performing conversions on an annual basis can balance out your long-term portfolio’s three tax structure accounts. If you’re trying to even out your taxable income across the years, regular Roth conversions can help you greatly.
3 Tax Structures You Can Invest Under for Your Long-Term Portfolio