Clever Tax Move for the Un- and Under-Employed
There are a lot of people who used to have a good-paying job but who have been unemployed or underemployed for more than a year. If you're one of those people, here's a clever tax move that can permanently cut your future tax burden.
If you used to have a good-paying job, you probably have some tax-deferred savings in an IRA or 401(k). You'll have to pay taxes on that money whenever you take it out.
So, here's the clever part: If you're unemployed or underemployed this year, your income is probably very low. If your income is low enough that you'll owe little or no income tax, seize this opportunity to shift a few thousand dollars from your IRA to your Roth IRA. The money will be taxed, but the tax will be near zero. And once the money is in your Roth, it'll be able to grow tax-free, potentially for decades, and then still be tax-free when you withdraw it. You'll have already paid the tax on it, only the tax will have been zero.
Of course, this tax move only works for a narrow slice of people, those who both:
- Have money in an IRA
- Have a very low taxable income for this year
But for that narrow group, the amount of tax savings could be substantial.
Note that it's too late to do this for last year. It is not, however, too early to start planning for this year. In particular, if your money is still in your former employer's 401(k), do a rollover to an IRA now, so that you'll be able to transfer the money to a Roth IRA before the end of the year.
How much should you move? That's kind of tricky. Ideally, you want to move as much as you can without having to pay any extra tax. But that's not so easy to calculate — it's about as much work as doing your taxes (and don't forget to consider state as well as federal). But, if you can steel yourself to crank through the numbers, the potential exists to permanently avoid ever having to pay the taxes that were only deferred when you put the money into an IRA or 401(k).
Especially for people forced into premature retirement, whose incomes are low now but will be higher once their pensions and social security kick in, this can be a great move.
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