As we approach the end of 2016, it’s a good time to take stock of your income for the current year and compare it to expected income in the future. Is your income unusually low this year? Do you expect a substantial income increase in future years? If so, it may be time to consider converting some or all of your traditional IRA funds to a Roth account.
The Roth is particularly attractive to Self-Directed IRA investors because assets in the Roth grow tax-free, as opposed to tax-deferred, and they are not subject to required minimum distributions. These can be inconveniences for any traditional IRA account – but avoiding RMDs can be a godsend for Self-Directed IRA investors, because many Self-Directed IRAs are primarily invested in illiquid assets such as real estate, private lending and tax liens.
The law allows you to ‘convert’ as much traditional IRA money as you like from a traditional IRA to a Roth IRA. There’s no 10 percent penalty on a conversion, even if you’re under age 59½. If you have money in an old 401(k) you can bring that over to a Roth IRA too – and get the benefits of tax-free growth and no RMD requirements.
You can even do so if you don’t qualify to contribute new money to a Roth because you earn too much money.
The catch, of course, is that once you roll money over from a traditional IRA or qualified workplace plan you must realize the amount of the rollover as income – and pay income taxes on that money.
Note: You must make the rollover happen by December 31st. The April 15th deadline that normally applies to contributions of new money does not apply to conversions. You can complete the deposit into the new account after the 31st of December – you have 60 days to do so for it to be considered a conversion rather than a distribution subject to early withdrawal penalties. But you must have the money out of the old IRA by the end of the day on December 31st to execute a conversion strategy.
Tip: Take a look at your current marginal tax bracket. Are you normally in the 35 percent tax bracket but only in the 25 percent bracket this year? Then convert just enough just enough to put you at the top of the 25 percent tax bracket at the end of the year but not more than that.
It is a much more efficient strategy if you can pay the income taxes without tapping retirement funds. That is, pay taxes out of taxable assets, rather than retirement funds. That way, you are maximizing the number of tax-advantaged dollars you have working for you.
Benefits for Self-Directed IRA owners
Generally the tax rules for Self-Directed IRA accounts are the same as those for conventionally invested accounts. But if you are nearing retirement, converting assets subject to RMDs into assets that are not subject to RMDs, you may be able to increase the amount of money you have invested in long-term projects. You won’t have to impose cash drag on your Self-Directed IRA portfolio by keeping cash ready to pay pending required minimum distributions.
American IRA, LLC specializes in providing third party administration for Self-Directed IRAs, and we’ve done hundreds of these rollovers for our own clients. If you are curious about how to execute a Self-Directed IRA conversion to a Roth, or just want to know more about the Self-Directed IRA option in general, call us today at 866-7500-IRA(472).
We look forward to hearing from you.