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Pay now, not later: The Roth conversion

A Roth conversion is one of the most common ways to reduce taxes on future retirement income.

There are several ways to do this: You can move funds from a traditional IRA into a Roth IRA, transfer funds from a traditional 401(k) into a Roth 401(k), roll over a traditional 401(k) into a Roth IRA or use a backdoor Roth IRA.

You’ll be taxed on the amount you convert in the year you do the conversion. It will be taxed as regular income, so you may want to work with a financial planner or tax expert to assess the implications of this.

For example, it could bump you into a higher tax bracket. One way to mitigate this tax hit is to convert over several years, taking smaller contributions than you would if you converted the entire amount at once.

Roth IRAs have income and contribution limits, but these don’t apply if you do a Roth conversion. If your income is too high to contribute to a Roth IRA, you may want to consider using what’s called a backdoor Roth IRA. To execute this strategy, you’d contribute to a traditional IRA, which has no contribution or income limits, and then roll it into a Roth IRA — paying the taxes when you do the conversion.

Another potential tax advantage to a Roth conversion is that Roth IRAs — and, as of 2024, Roth 401(k)s — don’t have required minimum distributions (RMDs). That means you have more control over when you withdraw your funds, so you may be able to minimize taxes by managing your withdrawals. Having lower overall RMDs in any given year may also help you stay in a lower tax bracket.

But, when it comes to Roth IRAs, always keep in mind the five-year rule: You can withdraw your contributions at any time, but you must wait five years to withdraw earnings. If you’re in your 60s and converting over several years, you may need to plan your withdrawals around this rule.

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Delay your retirement

Another way to minimize taxes on withdrawals from your pre-tax retirement accounts is simply to keep working. Typically, you have to start taking RMDs on traditional IRA, SEP IRA, SIMPLE IRA and retirement plan accounts at age 72 or 73. But if you keep working, you can defer RMDs from your current employer’s 401(k) until you retire. This only applies to the current 401(k), not those from previous employers, and to qualify you can’t own more than 5% of the company.

Bet on your longevity

A less common but potentially useful strategy is to buy a qualified longevity annuity contract (QLAC). You can purchase this deferred annuity with funds from a qualified retirement plan or IRA. You can convert up to $200,000 of your retirement account balance into a QLAC, and the balance used to calculate your RMDs will be reduced by the amount of the purchase until you start taking distributions from the QLAC, which you must do by age 85.

These are just a few strategies for reducing taxes on distributions from your pre-tax accounts. However, these strategies tend to be complex, so you may want to have them modeled by a financial planner or tax professional so you can keep more money in your nest egg.

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Vawn Himmelsbach Freelance Contributor

Vawn Himmelsbach is a journalist who has been covering tech, business and travel for more than two decades. Her work has been published in a variety of publications, including The Globe and Mail, Toronto Star, National Post, CBC News, ITbusiness, CAA Magazine, Zoomer, BOLD Magazine and Travelweek, among others.

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