Thinking about getting your graduate degree? Here’s one financial move to consider.
You are taking the next step in your professional development. You have decided to go to graduate school. You have been doing very well in your career up to this point. Now you’ve decided to pause and further your education. Congratulations! There’s no better capital than human capital. 💰
You’ve been making six figures for some time now and saving over 20% of your income. Your former employer’s 401(k) is well above six figures. Your income is going to be $0 for the next 2 years. There’s one financial move you should consider doing while you are in school. You should even consider it when you graduate and only have 6 months of income. Behold, the Roth conversion.
What is a Roth conversion?
A Roth conversion is moving funds from your Traditional IRA, pre-tax 401(k), or pre-tax 403(b) to your Roth IRA, Roth 401(k), or Roth 403(b). You are converting pre-tax money to post-tax money. The Roth conversion is different than a Roth contribution. You are not adding dollars to your overall retirement dollars like you do with your Roth contributions, you are simply moving dollars.
Who can make a Roth conversion?
Roth conversions can be completed by almost anybody. There are no income restrictions. Certain rules do apply if you are older than 72 and if you have non-deductible IRA dollars. If this is you, let’s talk!
How do I conduct a Roth conversion?
This is dependent on what type of account you are going to convert. If you are converting a Traditional IRA, then you can contact your investment custodian and provide them with your specific instructions. Various institutions are now allowing you to complete the conversion online now.
If you would like to convert within your pre-tax 401(k) or pre-tax 403(b), then contact your employer plan provider and ask if you are able to complete the conversion within the plan. If you are not able to, then you can establish a new Traditional IRA and Roth IRA at an investment custodian. Request a rollover from your employer-provided pre-tax plan to the Traditional IRA. Once the funds are deposited into the Traditional IRA you can process the conversion to your Roth IRA as we mentioned above.
Interested in completing a conversion? Contact Fyooz today 💸
How does this impact my taxes?
You haven’t paid taxes on your pre-tax account because you’ve deferred the taxes until you take a distribution. Converting pre-tax money to a Roth account means you have to pay taxes on the amount you are converting. Here are a few options for paying the taxes.
Pay the taxes on the transfer. Various custodians allow you to withhold taxes on the distribution. For example, if you converted $50,000 to a Roth IRA and elected to withhold 15% for federal taxes then the net amount going to your Roth IRA would be $42,500. You need to be careful with this strategy because you may be subject to a 10% penalty if the IRS determines that the amount you withheld S should be coded as an early distribution.
Pay the taxes when you file your taxes. If you elect this route, then you are deferring your tax payment until April of the following year. This may allow you some time to assess what your tax liability is going to be and how to save for it.
We help our clients plan for the taxes they can anticipate owing on a Roth conversion. Many of our graduate students can complete a Roth conversion while still walking away with an overall refund.
Why should I do a Roth conversion?
Your income is $0 😟. You should consider doing a Roth conversion when you anticipate being in a lower tax bracket today than in the future. It’s hard to know what tomorrow will look like, let alone retirement. But there’s a reason you’re going to graduate school. You are anticipating a higher salary or income in the future given your new skill set. Your income might be at $0 today while in school. I don’t think you’re paying for that MBA with the hopes of making $0 in the future.
It’s important to note that you have to take your spouse’s income into consideration when looking at your tax bracket – assuming you file your taxes Married Filing Jointly.
Here’s a breakdown of the tax brackets based on taxable income ⬇️.
10% for single filers: $0 - $10,275
10% for married filing jointly: $0 - $20,550
12% for single filers: $10,275 - $41,775
12% for married filing jointly: $20,550 - $83,550
22% for single filers: $41,775 - $89,075
22% for married filing jointly: $83,550 - $178,150
24% for single filers: $89,075 - $170,050
24% for married filing jointly: $178,150 - $340,100
32% for single filers: $170,050 - $215,950
32% for married filing jointly: $340,100 - $431,900
35% for single filers: $215,950 - $539,900
35% for married filing jointly: $431,900 - $647,850
37% for single filers: $539,900 +
37% for married filing jointly: $647,850 +
The market is down 📉. The S&P 500 is down over 20% this year. This means it might be the best time to convert. Why you ask? Let’s say you had $100,000 in your former employer’s pre-tax 401(k) when you left for graduate school last year. Now that account is down to $80,000 with the market down 20%. If you convert the money at $80,000 that means you are paying taxes on $80,000 as opposed to the original $100,000 value. This means your account will grow tax-free in the future. Fast forward and your account reaches the original $100,000 value. Now there is $20,000 of tax-free growth. Not bad?
How do I know how much to convert?
You should reach out to professionals for guidance on Roth conversions. Working with a financial planner and an accountant can help you plan for a successful conversion that can provide years of tax-free growth. Your professional will help you determine how much to convert before going into the next tax bracket.
Many of our clients have had the opportunity to gain their graduate degrees in various fields including a Master’s of Business Administration (MBA) or a Master’s of Public Health (MPH). They have benefited from completing a Roth conversion.
If you are ready to complete a Roth conversion, then let’s get started. Reach out to us today for a second opinion 👋
Disclaimer: This article is for informational purposes only and is not a recommendation of Fyooz Financial Planning, Natalie Slagle CFP®, or Daniel Slagle CFP®. Past performance may not be indicative of future results and may have been impacted by events and economic conditions that will not prevail in the future. Therefore, it should not be assumed that future performance of any specific security, investment product or investment strategy referenced in the article, either directly or indirectly, will be profitable or equal to the corresponding indicated performance level(s). No portion of the article shall be construed as a solicitation to buy or sell any specific security or investment product or to engage in any particular investment or financial planning strategy. Any reference to a market index is included for illustrative purposes only, as it is not possible to directly invest in an index. Indices are unmanaged, hypothetical vehicles that serve as market indicators and do not account for the deduction of management fees or transaction costs generally associated with investable products, which otherwise have the effect of reducing the performance of an actual investment portfolio.