Doing a Roth IRA Conversion? Suze Orman Says You Can Pay Your Taxes From Your Emergency Fund

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  • Converting a traditional IRA to a Roth could work to your benefit down the line.
  • While this type of conversion will result in an immediate tax bill, Suze Orman has an interesting strategy for covering it.
  • You can use emergency fund savings to pay the taxes, because if needed, your Roth IRA can also serve as an emergency fund.

It's an option worth considering.

Many people rely on their Social Security once they reach retirement age, but often, that's not enough. You'll likely need money to supplement your Social Security income once you leave work. And that's where your personal savings come in.

Many people sock money away in a traditional IRA and enjoy a tax break on their contributions. But the problem with traditional IRAs is that withdrawals are taxable in retirement. And at a time in life when money may be tight, many seniors would rather avoid losing a chunk of their income to the IRS.

With a Roth IRA, you don't have to. A Roth IRA won't give you an immediate tax break on the money you put in. But you will get to enjoy tax-free withdrawals in retirement. Plus, Roth IRAs are the only tax-advantaged retirement savings plan that doesn't impose required minimum distributions, which could force you to take withdrawals when you don't want them or otherwise risk steep financial penalties. So all told, you get a lot more flexibility with a Roth IRA.

Converting from a traditional IRA to a Roth IRA

If you don't have a Roth IRA -- say, you've always stuck to a traditional IRA, or your income is too high to contribute to a Roth IRA -- then you have the option to convert a traditional IRA to a Roth. That way, you can enjoy all of the benefits a Roth has to offer.

There's just one problem with going this route: having to pay taxes on the sum you convert. Remember, Roth IRA contributions are not tax-free like traditional IRA contributions are. So if you do a conversion, you'll have to pay taxes on the sum you convert right away (meaning, not that day per se, but for that tax year).

If you're worried about covering that tax bill, financial expert Suze Orman has a great suggestion. And while it may seem a bit unconventional, it works.

You can raid your emergency savings to cover a Roth IRA tax bill

You may not have the ability to cover the taxes on a Roth IRA conversion without raiding your savings account. But Suze Orman insists it's okay to do so.

You may be thinking, "What on earth?" After all, we're always told to leave our emergency savings alone unless it's an actual financial emergency -- which a Roth IRA conversion is not. So doesn't that break the rule?

The answer is yes, this does break that rule. But it's also okay for one big reason: If needed, your Roth IRA can also serve as your emergency fund.

Because there's no tax break on the money that goes into a Roth IRA, there's no penalty for taking an early withdrawal as long as you're only touching your principal contributions, not the gains portion of your account. But let's say you need $10,000 to cover a Roth IRA conversion tax bill. Suze Orman says that if you take it out of your emergency fund and then need $10,000 in a pinch, guess what? You can tap your Roth IRA to the tune of $10,000. So all told, you're not really in a worse financial position.

A reasonable strategy to employ

It's generally a good idea to not touch your emergency fund unless you're in a precarious financial spot. And it's generally a good idea to leave your Roth IRA alone and reserve those funds for retirement.

But in this one situation, Orman insists that it's okay to break both rules -- you can pay your Roth IRA conversion tax bill out of your emergency fund, and you can have your Roth IRA sub in as your emergency fund if needed as a result of having slashed your balance to cover that tax bill. So if you're interested in doing a Roth IRA conversion and are worried about paying the associated taxes, you may now have an option you never thought of before.

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