When I made the decision to convert my old pension into a Roth IRA, I was feeling pretty optimistic about my financial situation. I knew I’d owe taxes on the conversion unless I rolled it over into a regular IRA or rollover IRA account. But I figured we could afford it. It didn’t hit me that I had made a wrong decision until I started working on my taxes. Converting my pension into a Roth meant I’d owe several thousands of dollars in taxes that I simply didn’t have. Fortunately, I had the option to do a Roth IRA re-characterization, a fancy word for changing my mind. My pension would end up in a taxable, traditional IRA account. When I’m retired, I’ll be taxed on the money I take out of the IRA instead of being able to withdrawal it tax free as I would with a Roth.
Planning ahead for next year
Fortunately, I was able to lower my tax bill this year. But I’m worried about the future. I’d love to covert some of my Rollover IRA money into a Roth IRA. I decided to sit down and do some careful planning before converting money which can become a tax liability. I decided if I only convert $1,000 to $2,000 each year, I should be able to afford the taxes. In a worst case scenario, I can again do a Roth IRA re-characterization to basically “un-do” the conversion. However, I rather avoid the extra paperwork with better planning.
Funding my Roth 401(k)
It’s difficult to figure out whether to contribute to the Roth 401(k) or the traditional 401(k) at my job. If I contribute to the traditional account, it will lower my taxable income so I don’t pay as much in taxes now. However, if I contribute to a Roth 401(k), I’ll have more tax free income when I’m retired. Because I was burned this year, I decided to keep at least 3 percent of my paycheck going toward the traditional 401(k) so that I can lower my taxable income. My husband also contributes to his regular 401(k).
Most people think about the tax advantages of a Roth IRA or a Roth 401(k). But there are other advantages for us to fund our Roth accounts. If I lose my job, I can rollover my Roth 401(k) into a Roth IRA. At that point, I’m allowed to spend any of my contributions to the account even though I can’t touch the earnings until I reach retirement age. If I want to lower my tax bill last minute in the future, I will keep in mind the option to re-characterize a Roth. However, in the ideal world, I would leave as much money as I could in Roth accounts. It will be better for my future.
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Saving up $3 Million for Retirement
Why Rich People Feel Hated
Making the Leap from My Money to Our Money