My name is Joseph Reinke and I am an investment expert with over 20 years of experience in the financial industry. Over the years, I’ve helped thousands of new grads in managing over $2.6 billion in assets and debt.
Today, we are going to go over the differences between a ‘Roth Conversion’ and ‘Rollover’. These two financial strategies are often misunderstood, yet they are important for efficient retirement planning. They each have their own unique advantages, and understanding them can greatly influence your financial future.
The Starting Point
There are three terms that people often get confused about Roth Conversions, Rollovers, and Roth Rollovers.
I’m going to briefly describe each below.
Brief Understanding of a Roth Conversion
A Roth conversion is a financial strategy that allows you to transfer your assets from a Traditional, SEP or SIMPLE IRA into a Roth IRA. This action is often termed as “converting” your assets. During this process, you’ll have to pay income taxes on the pre-tax dollars moved into the Roth IRA.
The benefit is that your money then grows tax-free, and qualified withdrawals in retirement do not incur taxes. Keep in mind that the specifics of Roth conversion are subject to IRS rules and individual financial situations can greatly impact the results. Also, to reduce the tax impact when you convert your account, you can incorporate a Roth Conversion Ladder strategy into your financial plan.
Case Study: Using Roth Conversion to Maximize Retirement Savings
Let’s consider an example of a FitBUX member, Samantha, who successfully used a Roth Conversion to her advantage. Samantha, a 32-year-old physical therapist, had accumulated a significant amount in her Traditional IRA over the last eight years. After a detailed financial review, we identified an opportunity for Samantha to optimize her retirement savings by converting her Traditional IRA to a Roth IRA.
Samantha’s relatively lower current tax bracket provided an opportune window for executing this conversion. She elected to pay taxes on the converted amount upfront, which were substantively lower due to her current tax bracket. By converting her Traditional IRA to a Roth IRA, Samantha took advantage of tax-free growth and tax-free withdrawals in retirement.
This strategy allowed her to mitigate the risk of potentially higher tax rates in the future. It’s important to remember that Samantha’s success with the Roth Conversion strategy is based on her unique financial situation and may not be a suitable strategy for everyone.
For a more in-depth understanding of Roth conversions, you can visit our article HERE that has everything you need to know.
What Is A Rollover?
A Rollover refers to the process of moving your retirement savings from a 401(k) or 403(b) plan into a Traditional IRA. Unlike a Roth Conversion, a rollover typically occurs when you leave an employer and want to take your retirement savings with you.
Sometimes, individuals will strategically rollover their old employer 401(k) and then do a Roth conversion afterward!
Rollover Example
Suppose you’ve recently left a job where you had a 401(k) plan. The total amount in this plan is $50,000. Rather than leaving this money with your old employer’s plan, you want to take it with you. To do this, you will need to perform a rollover. You would set up a Traditional IRA account, and then instruct your 401(k) plan administrator to move the funds directly into your new IRA. This is often referred to as a “direct rollover”. The key benefit here is that this transaction is not subject to any tax or penalty. Your retirement savings continue to grow tax-deferred, and you gain more control over your investment options.
For a more in-depth understanding of rollovers, visit our comprehensive guide HERE.
Roth Rollover
A Roth Rollover refers to the process of moving your retirement savings from a Roth 401(k) or Roth 403(b) plan into a Roth IRA. Since the funds are already in a Roth account there is no need to do a Roth conversion. I.e. you roll it over and you are done.
Member Scenarios with Rollovers
Let’s look at some real-life scenarios involving our FitBUX members to better illustrate the concept of Rollover.
Scenario 1: Member Transitioning Jobs
Let’s use Alex, a member who recently transitioned jobs. Alex had a sizeable amount in 401(k) with his previous employer, and when he left, he decided to roll over his 401(k) into a Roth IRA. This allowed Alex to continue growing his retirement savings tax-free and without having to manage multiple retirement accounts. He reached out to our FitBUX Experts who guided him through the entire process, ensuring a smooth rollover with minimal tax implications.
Scenario 2: Member Reaching Retirement Age
The second scenario involves Susan, a member who recently reached the age of 59.5. With retirement looming, she decided to consolidate her retirement savings. She rolled over her 403(b) into a Roth IRA for more control over her investment choices and to enjoy tax-free withdrawals during her retirement. Our FitBUX Experts helped Susan to understand the tax implications and assisted her in making the rollover process simple and efficient.
While these examples highlight successful Roth Rollover cases, everyone’s financial circumstances are different. It’s always recommended that you consult with an accountant or one of our FitBUX Experts to ensure this strategy is right for you.
If you’re looking at potentially doing a Roth rollover, please schedule a call with one of our FitBUX Experts and they’ll walk you step by step on how to navigate this daunting process.
Common Misconceptions
When it comes to financial planning, myths and misconceptions often cloud the reality, leading to confusion and potential mistakes. Roth Conversions and Rollovers are no exceptions. Here are some common misconceptions:
Misconception 1: Roth Conversion and Rollover are the Same Thing
While both strategies involve moving funds into a Roth IRA, they are not the same. Roth Conversion refers to moving funds from a Traditional, SEP or SIMPLE IRA into a Roth IRA, while a Roth Rollover typically involves moving funds from a Roth 401(k) or Roth 403(b) into a Roth IRA.
Misconception 2: You Will Always Pay More Taxes Now with a Roth Conversion
While it’s true that you will pay taxes on the amount converted during the year of conversion, it doesn’t necessarily mean you’ll pay more taxes overall. If your tax rate during retirement will be higher than your current rate, the upfront tax payment could be less than the tax on future distributions from a traditional IRA. Also, if you are currently in a low tax bracket, you may pay no taxes at all!
Misconception 3: Roth Rollovers are Always Tax-Free
Although Roth Rollovers are generally tax-free because contributions were made with after-tax dollars, there may be tax liabilities on earnings that are rolled over if they’re not part of a “qualified distribution”.
Misconception 4: Roth Conversion or Rollover is Always a Good Idea
Whether a Roth Conversion or Rollover is beneficial depends on several factors like your current and expected future tax rates, your age, financial goals, and retirement plans. What works best for one individual might not work the same for another.
Conclusion
Navigating Roth Conversions and Rollovers can be challenging, but understanding the key differences is essential for strategic financial planning.
To recap, Roth Conversion refers to the process of moving funds from a Traditional, SEP, or SIMPLE IRA into a Roth IRA and typically becomes beneficial when you expect your tax rate to be higher in retirement. On the other hand, Roth Rollover is usually a strategy considered when leaving an employer as it allows you to roll over funds from a Roth 401(k) or Roth 403(b) into a Roth IRA, often to consolidate retirement savings and increase investment options. Both strategies offer the advantage of tax-free withdrawals during retirement, with taxes on Roth Conversions due at the time of conversion.
If you have any further questions or concerns about Roth Conversions or Rollovers to see if this is something to consider, don’t hesitate to reach out to us at FitBUX. Our team of experienced experts is ready and eager to help clarify these concepts and guide you in making decisions that best suit your individual financial situation. Feel free to schedule a call with one of our FitBUX Experts. Remember, personalized advice can make all the difference in your financial planning journey.
