If you withdraw from a Roth IRA, you don't pay any taxes. That's because a traditional IRA is funded with pre-tax dollars and a Roth IRA is funded with after-tax dollars. Here are some of the strategies you can use to minimize the taxes you'll pay when you withdraw money from your IRA. Possibilities include converting traditional IRAs into Roth IRAs, having several IRAs, investing in gold in an IRA account, donating IRA values to a charity, or creating a QLAC. Since many of them involve some complexity, you may want to consult a financial advisor so you don't risk having to pay a large tax bill at the end of the year.
When you invest in a Roth IRA, you deposit your money once it's been taxed. When you withdraw money, presumably after you retire, you don't pay taxes on the money you withdraw or on the profits you earned with your investments. As shown in the table, the traditional IRA allows you to contribute to your pre-tax income, so you don't pay income taxes on the money you invest. If you find yourself in a lower than usual income tax bracket in a year, you may want to transfer funds from a traditional IRA to a Roth IRA up to the contribution limit of that tax bracket.
If this were not necessary, people could continue to allow money to grow tax-free while delaying the payment of income tax on the funds in the account. Depending on your situation, you may have several options available to avoid taxes on the withdrawal of an IRA. You won't owe any income tax as long as you leave your money in a traditional IRA until you reach another key age milestone. This will reduce the taxes you pay now and allow you to withdraw tax-free money from the Roth IRA in the future.
Account profits are subject to deferred taxes, so dividends and capital gains generated can be accumulated while they are in the IRA. If you expect your tax bracket to be higher when you retire than it is now, it may make sense to convert your traditional IRA to a Roth IRA. For example, some investors deposit their shares in one IRA, their bonds in another, and alternative assets, such as cryptocurrencies, in a self-directed IRA. The IRA can be an incredible tool for planning for a good retirement, but you'll need to understand the tax implications of your choice to get the most out of the program.
If you think you may need emergency funding before you retire, consider investing at least part of your money in a Roth IRA so you can access it without penalty if needed. Deciding what investments you keep in a Roth account or a traditional IRA can make a big difference in the taxes you owe. That way, you'll never have to touch the money or risk paying taxes for accidental early distribution, says Kristi Sullivan, certified financial planner with Sullivan Financial Planning LLC in Denver, Colorado. An IRA is like a “wrapper” surrounding a financial account that gives you special privileges, especially when it comes to the taxes you must pay.
The Roth has other benefits when it comes to planning your wealth, for example, and the peace of mind that you'll never have to pay taxes on IRA withdrawals is worth a lot to some investors, perhaps even more than current tax savings.