Understanding ACA and Roth Conversions

Background

Roth conversions involve moving money from a traditional retirement account, such as a 401(k) or IRA, to a Roth account. When you withdraw money from a traditional account, you pay taxes on the full amount. In contrast, Roth accounts grow tax-free, and withdrawals in retirement are tax-free as well.

Considerations for ACA and Roth Conversions

ACA Implications: Roth conversions increase your current taxable income, which can affect your eligibility and the amount of premium tax credits you qualify for under the Affordable Care Act (ACA).

FAFSA Implications: Roth conversions can also affect your eligibility for financial aid under the Free Application for Federal Student Aid (FAFSA). Roth withdrawals are considered income on the FAFSA, regardless of whether the money has been in the account for five years or not.

Potential Benefits of Roth Conversions

Tax-Free Withdrawals: Converting to Roth accounts can provide tax-free growth and withdrawals in retirement, reducing your overall tax burden in the long run.

ACA Flexibility: Converting to Roth accounts early in your career can create MAGI flexibility during your early retirement years. By having a lower MAGI, you may qualify for lower ACA premiums and higher subsidies.

Potential Drawbacks of Roth Conversions

Upfront Taxes: Converting to Roth accounts requires paying taxes on the full amount converted. If you are in a high tax bracket, this can be a significant expense.

Limited Access to Funds: Roth accounts have a five-year waiting period before you can access the principal tax-free. If you need to access funds before then, you may have to pay taxes and penalties.

Alternative Strategies

Tax-Gain Harvesting: Selling appreciated assets in taxable accounts to generate short-term capital gains can help reduce your tax liability without affecting your ACA or FAFSA eligibility.

Traditional Retirement Accounts: Continuing to contribute to traditional retirement accounts can provide tax deductions now and tax-deferred growth until retirement. However, RMDs can increase your MAGI in retirement.

Conclusion

Roth conversions can be a valuable tool for long-term financial planning. However, it is important to carefully consider the potential implications for ACA and FAFSA eligibility before making a decision. Consult with a qualified financial advisor to determine the best strategy for your individual circumstances.