15 Common Roth Conversion and Savings Mistakes People Make

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Editor's Note: This story originally appeared on NewRetirement.

It is highly likely that you have considered saving (or converting existing savings) into a Roth IRA or 401(k).

Someone, a friend, family member, advisor, your bank, or colleague may have recommended it to you. And, you have most certainly seen, if not read, an article about the benefits of Roth.

All retirement savings accounts are designed to help you save money on taxes. And, Roths can be a particularly great way to reduce your tax burden.

What’s a Roth?

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A Roth is a retirement savings account. With a Roth, you pay taxes on the money you contribute to the account.

The trade-offs (and reasons they are wildly popular) are that your money grows tax-free, withdrawals are not taxed, and you are not required to take minimum distributions at any certain age. (Learn more about the benefits of a Roth.)

With a traditional 401(k) or IRA, your savings contributions are tax deferred. You don’t pay taxes on the money you save.

Roths can be fantastic, but are not always for everyone and significant mistakes can be made. The following are mistakes to avoid with Roth accounts.

1. Not Opening a Roth Because You Already Have a 401(k)

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There are two main types of retirement savings accounts: IRAs (traditional and Roth) and employer-sponsored retirement accounts like 401(k)s (traditional and Roth), SEPs, 403(b)s, etc.

If you are saving into a retirement plan at work, you are still allowed to save into an IRA or a Roth IRA and, if you have the cash flow, you probably should.

You are allowed to contribute to both a Roth IRA and your employer-sponsored retirement plan.

The limit for contributions to IRAs (Roth and traditional) for 2024 is $7,000 plus an additional $1,000 in catch-up contributions if you are 50 or older.

The 401(k) annual contribution limit is $23,000 for 2024, plus a $7,500 catch-up contribution if you are 50 or older.

2. Not Taking Advantage of a Roth Because You Make Too Much Money

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It’s true, there are income limits when it comes to contributing to a Roth account.

In 2024, you can only save into a Roth if your modified adjusted gross income (MAGI) is below a certain threshold. Check out the latest income limits set by the IRS.

However, the income limit should not discourage you from taking advantage of Roth accounts.

While you can not save directly into a Roth, you can save into a traditional IRA and convert those monies into a Roth. This is often referred to as “backdoor” Roth savings.

Learn more about the backdoor Roth.

3. Converting Money to a Roth Without Following the Rules

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When converting money from a traditional retirement savings vehicle to a Roth, you need to follow the rules for the conversion. You can do a:

  • Rollover: A rollover is when you take distribution from your traditional IRA and are sure to deposit that money in a Roth account within 60 days.
  • Trustee-to-trustee transfer: This is where you direct the institution that holds your traditional IRA to transfer the funds to a different institution where your Roth account is held.
  • Same-trustee transfer: In this case, both your traditional and Roth accounts are with the same institution, and you direct them to make the transfer.

If you were to simply withdraw the funds from your retirement plan and put them into a Roth IRA, you could be assessed a 10% early-distribution tax.

4. Withdrawing Converted Roth Funds Too Early

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The beauty of a Roth is that the funds grow tax-free. So, in general, you want time for the account to grow after you have done a Roth conversion.

More specifically and importantly, it is very important to know that converted Roth funds must remain in your Roth IRA for at least five years before withdrawal.

Withdrawing the money before five years have passed will result in a 10% early withdrawal penalty.

5. Contributing Too Much to a Roth

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As noted above, there are limits to how much you can contribute to a Roth. The IRS will charge you a 6% penalty tax on any investments that are in excess of the limits.

The penalty is assessed for each year in which you have not taken action to correct the error.

6. Not Having the Cash Flow Available to Pay Taxes on a Roth Conversion

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Unlike contribution limits, there are no limits to how much you can convert to a Roth. However, you must be able to pay the taxes due on the conversion.

Your conversion may be limited by how much tax you can afford in any given year.

The converted funds will be treated by the IRS as income and taxed as such.

7. Improper Planning of When to Do Conversions

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The timing of when to do Roth conversions is tricky.

What can get complicated is deciding the timing of how much to do and when. There are many important factors to consider:

  • Your income (current and future)
  • Your tax bracket (current and future)
  • Future changes to the tax code
  • How much money you have in traditional accounts and the value of the Required Minimum Distributions (RMDs) when you become of age
  • Available cash to pay taxes on conversion
  • How much time between the conversion and when you will start to withdraw funds
  • The rate of return you will make on the Roth funds
  • Your goal for doing conversions: For example, do you want to minimize lifetime taxes? Stay below a certain tax or IRMAA threshold? Maximize your estate value?

It can be complicated trying to figure out how much to convert and when. Many people find that it is best to spread out conversions and have a multi-year conversion strategy.

8. Not Investing Appropriately

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Tax-free growth is the name of the Roth IRA game. As such, you want to make sure that your funds in a Roth IRA are invested for growth that is appropriate for your age and risk tolerance.

9. Using a Roth When You Are in Your Highest Tax Bracket

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If you are in your highest-earning years, chances are you’ll probably be better served with traditional contributions than Roth during those years.

And, if you think taxes will be lower in the future, a Roth conversion probably is not for you right now.

The NewRetirement Planner can give you insight into your tax bracket for all future years. This can help you see opportunities for doing Roth conversions.

10. Not Modeling Your Future Income

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Many people think that their income will fall in retirement and that taxes will not be a factor.

However, this may not be true, particularly if you have significant retirement savings. Required Minimum Distributions (RMDs) may push your income levels into higher tax brackets.

Modeling future income enables you to understand whether Roth savings or a Roth conversion is a good idea for you.

11. Overlooking Your Spouse’s Opportunities for Saving

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For better or worse, very often in couples one partner is more involved with the household’s financial health than the other — even if you are both bringing in income.

And, sometimes this imbalance means that the financially savvy partner is making all the right moves with his or her money, but are not necessarily taking advantage of partner opportunities.

If your spouse has income, make sure they are saving in the most advantageous vehicles possible, which may be a Roth account.

12. Overlooking Opportunities to Save for Your Spouse (Even if They Don’t Have Income)

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In general, you need to have earnings in order to save in tax-advantaged savings vehicles.

However, if you are married and file a joint return, then you can max out a Roth IRA for each spouse by using a spousal IRA. You can contribute on their behalf and the annual individual contribution limits are the same.

So, if you are married, both over 50, file a joint return, and only one spouse has income, you can still contribute a maximum of $16,000 for your household. ($7,000 plus an additional $1,000 in catch up contributions for each of you.)

13. You Think You Are Too Old or Too Young to Contribute to a Roth

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There is no age restriction for contributing or converting funds to a Roth IRA.

The real factor to consider is your tax liability for one type of savings vehicle or the other.

14. Not Naming and Updating Beneficiaries

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This is not necessarily specific to Roth accounts, but not naming and updating beneficiaries for accounts is a mistake often made. And, it is very relevant to Roth accounts.

Not having a beneficiary or having the wrong beneficiary will seriously derail your estate plans.

15. Not Considering Roth Savings and Conversions in Light of a Comprehensive Financial Plan

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No financial decision should ever be made without understanding the pros and cons in terms of both your current and future overall financial picture.

There are so many considerations that will impact the real benefit (or downside) of doing a conversion. For example, your family and potential inheritance can be impacted by whether or not your savings are in a Roth.

Maintaining a comprehensive written financial plan is a great way to model the impact of your decisions.

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