Why You Need to Consider a Roth IRA Conversion

What is a Roth IRA Conversion?

An IRA conversion, also known as a rollover, generally refers to the act of transferring assets held in a traditional IRA, or a similar retirement account, to a Roth IRA. Most investors can convert their IRA to a Roth even if they earn too much money to contribute to a Roth IRA directly.

What plans can you convert?

The types of IRAs you can rollover to a Roth IRA are:

  • Schedule a Free Tax ConsultationTraditional IRA
  • Rollover IRA
  • Simple IRA
  • 401K or 403(b) from a former employer
  • 457(b)

What are the benefits of converting to a Roth?

While Traditional IRA accounts require you to start withdrawing minimum amounts once you turn 70 ½, there are no required minimum distributions (RMD) for a Roth account. These amounts are set by the IRS and failure to withdraw the RMD will lead to penalties. The fact that no RMD apply to a Roth account allows you to better control the amount of distributions you want to take and not be forced to do so by the IRS.

Also, if you don’t need to tap your IRA funds during your lifetime, converting to a Roth allows your savings to grow undiminished by RMDs, potentially leaving more for your heirs—who will also benefit from tax-free withdrawals during their lifetimes.

Another benefit that could be applicable to you is that converting to a Roth IRA early, while you are in a lower tax bracket, can help you put more money in your pocket later when you retire. This can also be beneficial if you feel that the government will be raising taxes over the course of your lifetime. Keep in mind that although the new tax reform reduced the tax rates for most Americans, these tax reductions are not permanent and are set to expire after 2025. It is quite possible, and plausible, that future tax rates will be higher than the current ones.

pros and cons of converting to a Roth IRA

What are the drawbacks of a Roth IRA conversion?

The biggest drawback you need to consider is that a Roth conversion is a taxable event, which means that any assets you convert to a Roth account will be included in your gross income. The tax bill on a conversion can be a massive one.

For example, let’s look at a married couple with $150,000 in taxable income. Say they want to convert $100,000 to a Roth account. Currently, their federal tax bracket is 24%, however, if they convert the entire $100,000 in one calendar year they will jump a tax bracket to 32%. Furthermore, they could possibly lose certain tax credits based on income such as the American Opportunity Tax Credit (Education Credit). This could lead to this couple paying up to $10,000 in additional taxes.

The decision to convert to a Roth IRA doesn’t have to be all or nothing, though. You may find dividing your savings among a Roth and traditional IRA and/or a Roth and traditional 401(k) is the optimal solution.

In the above example, they could choose to do the conversion over three calendar years. By converting a third today, the second third on January 2nd, and the final third on January 2nd of the following year, they avoid being pushed into a higher tax bracket. It would only have taken them approximately 15 months to convert the entire $100,000, and they saved thousands in tax liability.

Aside from the tax implications, another potential drawback is that if you are younger than 59 ½ you will need to keep the money in a Roth for 5 years before taking any distributions from the Roth. Any distribution earlier than the 5-year period will impose a 10% early withdrawal penalty. There are exceptions to this rule, so again, consult a tax advisor.

There could be many different scenarios and many different considerations. If you really want to find the ideal solution for you, then we recommend that you consult with an experienced tax advisor.

How do you convert to a Roth IRA?

If you do decide a Roth IRA conversion is right for you, you’ll need to determine two things:

  1. When to execute the conversion: You may want to carry out multiple Roth IRA conversions over several years. If done properly, a multiyear approach could allow you to convert a large portion of your savings to a Roth while limiting the tax impact. Early in retirement—when your earned income drops but before RMDs kick in—can be an especially good time to implement this strategy.
  2. How you’ll pay the resulting tax bill: Ideally, you’d have cash on hand outside your IRA to pay the income tax on any converted funds. The main reason is that any IRA money used to pay taxes won’t be accumulating gains tax-free for retirement, undermining the very purpose of a Roth IRA conversion. There are other tax effective ways to pay the tax bill on the conversion that require further analysis by a tax advisor.

Converting to a Roth IRA is a powerful tool that can give you the potential to cut your tax bill in retirement but be sure to consult a qualified tax advisor before making the move.

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Focus on Making Money

Today’s piece will be somewhat short and sweet. One of the most important things you need to do to be successful when short term trading for income is to have proper focus. What I mean is this… as a short term income trader, all you need to do each day is look at a chart, apply the Supply/Demand strategy and focus on where banks are buying and selling that day. The hard part is to only focus on that.

Below is an S&P trade that we took in my live trading session with our members. One of the levels we focused on was the supply zone highlighted as special. These buy and sell areas are found by locating on a chart exactly where banks and financial institutions are willing buyers and sellers. The key is to follow our rules and perform our rule-based analysis well before the market gets going and well before our trades take place.

How to see high probability trades on a price chart.

Bank supply that day in the S&P was in the range you see above. With an entry at the supply zone, a protective buy stop above it and a profit target at the blue line below, this was a 5:1 trading opportunity (risk 1 to make 5).

On the chart below, once the market got going, price rallied to our supply zone and then proceeded to decline from that level to our profit target, risking 1 to make at least 5. Had the trade not worked out, not a big deal, it was a risk we were willing to take because the chart suggested a high probability opportunity.

stock trade chart illustration

What makes this focus so hard for most people is all the other things they let sneak into their decision making process. They also let emotion play into the trade which will typically lead to a smaller trading account. They overcomplicate what is really not that complicated. The focus needs to be 100% on where the bank and financial institution’s buy and sell orders are that day and then buying and selling there, nothing else. When it comes to profitable trading, knowing the details of what is happening to the European economy or with the Fed is as important as knowing which black socks I’m going to wear that day, who cares…

Free Trading WorkshopWhen people use the term 100%, most of the time it’s a figure of speech, I am not using it as a figure of speech. Profitable trading goes hand in hand with profitable thinking, 100% of your focus needs to be on one thing and one thing only: where the significant institutional buy and sell orders are, period. As I always write about, we do this by learning how to identify supply and demand zones on a chart. We look for the picture that represents a major supply and demand imbalance and then take action at that zone. Some people will want to also include some indicators: Fibonacci levels, maybe the latest oscillator… wrong again… you need to have a razor sharp focus on where the major buy and sell orders are, nothing else matters.

Now that I have repeated myself a few times, hopefully you get the point and I will not waste your time with more repetition. This is just my opinion, of course, but from my experience nothing else matters when you know where institutions are buying and selling in a market, and that’s the focus of Supply and Demand. If you don’t agree, that’s fine as well, this is what makes a market. Next week we will focus on why that zone was special and how the order flow behind the candles work.

Hope this was helpful, have a great day.

Sam Seiden – sseiden@tradingacademy.com

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Return on Investment and Risk

1The idea of getting a return on an investment is the cornerstone of saving and investing. With every investment comes some form of risk. As we evaluate our choices for investing, it’s important to think about how reward and risk are related. How much and what kind of risk we can tolerate will determine what kind of assets we will invest in.

The term risk in an investment context covers several very different things.

Risk of Physical Loss

This kind of risk applies to assets that we have in our physical possession, like currency, precious metals, collectibles or real estate. Usually, we protect ourselves against this type of risk through physical safeguards (safes, guard dogs, insurance, etc.). This is not a risk that usually plays a big part in our investment decisions.

How risk impacts your ROI, return on investment.

Risk of loss of principal

This return on investment applies to assets whose return normally comes mainly from increases in value, not from cash flow. What goes up can also go down. This applies most obviously to common stocks and commodities, but also affects precious metals and real estate. To a smaller degree it affects preferred stocks and bonds. In general, it is the case that all assets that have the capacity to produce a large gain in any given year, also have the capacity to produce a large loss.

Stocks have been one of the two engines of long-term wealth-building (real estate being the other). Over the long term, the stock market has, on average, had a return on investment of returned around 10% (large caps) to 12% (small caps) per year, including price change and dividends.

But individual rolling twelve-month return on investment in the stock market have rarely been anywhere near the average. Twelve-month returns have ranged from a loss of 63% (12 months ending June 30, 1932) to a gain of +135% (12 months ending June 30, 1933), both including dividends. Even if you want to throw out the great crash and depression as outliers, we are still left with many very large swings. There were quite a few years whose returns were worse than -20%, some as bad as -40%; and also, quite a few that were better than +40%.

Free Trading WorkshopThe point is, the long-term average stock market return of 10-12% doesn’t happen every year; in fact, it rarely happens in any year. It is only over long time periods that the long-term averages assert themselves. In any one year, literally anything can happen in the stock market. And no one rings a bell at the top. The same is true of other volatile markets including real estate and precious metals. If we happen to be very unlucky and push in all our chips just before a big crash, then from our point of view the average rate of return on the stock market could be a big loss.

Risk of loss of purchasing power

This one is not as obvious as the others.  Nevertheless, it is a real risk. If you put a hundred-dollar bill in your wallet and leave it there for five years, it will still be a hundred-dollar bill when you spend it. However, it will not buy as much as it would have when you put it away. If inflation over that five-year period was at a typical 2.9% annual rate, that hundred dollars will only buy 86.7% of what it would have originally. You have lost over 13% of your original purchasing power, even though you still have the same number of dollars.

Although this risk can be seen most clearly when we think about cash, it also applies to any investment whose return is near or below the rate of inflation. This is most likely to be true of safe assets whose return is mainly in the form of cash flow, meaning dividends and interest rather than capital gains.

This risk of loss of purchasing power is what we run into when we attempt to guard against risk of loss of principal. You could say that inflation is a tax on caution. If your savings/investments don’t earn enough to maintain purchasing power after inflation, then they are not making enough to earn their keep.

So where does that leave us? Putting everything in the stock market would give us too much risk of losing principal. Avoiding that risk by leaving all of our money in the bank, on the other hand, gives us too much risk of losing our purchasing power to inflation. Using other assets gives us varying degrees of both these risks. Attempting to avoid the problem by hiring someone else to manage our money may just compound it because of their fees.

Selecting investments to diversify risks and managing them to reduce risks

You have no doubt heard that wealthy people get and/or stay that way by cultivating multiple streams of income. This is really another way of saying that wealthy people diversify their risks. If an investor has cash flow from some combination of businesses, bank interest, bond interest, preferred stock dividends, real estate rents and other sources, then they can weather occasional periods when their stock market investments or real estate lose value.  There is no need to fear the bear markets if other investments take up the slack in those times. Diversification itself reduces overall risk and helps to ensure you will have a positive return on investment.

But we can do better than that. If we can also at least partly avoid the loss of value in the bear markets for our volatile, money-making assets, then we would be hitting the sweet spot.

That is what our Proactive Investing model is designed to do. In a very brief nutshell, the approach is to select a diversified group of assets, so that we have cash flow coming in at all times; and then to manage each of those assets individually so as to minimize its individual risk. It sounds simple, and it is, once the details have been laid out. If you’d like to know more, contact your local center.

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Blue line – expected price path

Trading recommendations for today: watch for potential buying opportunities.

The material has been provided by InstaForex Company – www.instaforex.com