Time to Revisit That Roth Conversion?
by: James Moyer, CFP
Thanks to the recently enacted Tax Cuts and Jobs Act, now could be the best time to convert
your traditional IRA into a Roth IRA.
Roths have been in the public eye since 1997 when Congress passed the Taxpayers Relief Act. Due to income limitations and high tax brackets, however, many individuals have been unable to take advantage of the Roth, either through annual contributions or conversion of a traditional IRA.
What makes the Roth so special? Both types of IRAs allow assets to grow on a tax deferred basis, but there are three key differences. The first has to do with the deductibility of the annual contribution. Some individuals can fund a traditional IRA with pretax dollars - that is, a tax deduction is received when the contribution is made - but Roth IRAs are funded with after-tax dollars, so the annual contribution is not deductible.
The second difference, and the great appeal of the Roth IRA, is how the assets are taxed in the future. Contributions to an IRA will grow tax-free until you start to withdraw from it, then you will pay ordinary income taxes on each withdrawal. With a Roth IRA, you never have to pay taxes on it again, meaning the growth is completely tax-free upon distribution (though at that point you must have had the account opened for at least five years and be over the age of 59½).
The third, and what we believe to be the most important difference to retired individuals over age 70, is that required minimum distributions (RMDs) do not apply to the Roth IRA. As a reminder, when one reaches age 70½, the IRS requires annual distributions based on the age and account balance of the traditional IRA owner. High-income earners tend to retire with large IRA balances, and they often do not need to withdraw. Being able to avoid taking RMDs is a huge financial benefit, one that should greatly increase the value of your assets over time, if not for you, then for your heirs.
Here are a few scenarios in which a Roth conversion may be the best choice for you.
- If your effective tax rate this year will be less than what it was last year under the 2017 tax brackets, you might want to capitalize on the decrease in rates before they revert back to 2017 levels in 2026 (the new tax law sunsets at the end of 2025).
- Your tax bracket may be higher during your retirement years. In practice, we have seen this happen when clients turn 70½ and have to start taking required minimum distributions.
- You are just starting your career and have many more working years to go. Because you haven't hit your highest income earning years, you should take advantage of the lower tax rates you are subject to. Each year your income rises, your taxes will as well.
- Some people are fortunate enough to not need their IRA funds in retirement, and they want to leave that money to their heirs. Converting your traditional IRA to a Roth IRA will allow you to avoid taking RMDs when you turn 70½, which over time can maximize the benefit for your heirs.
- Along with the new tax changes come opportunities - ones that may benefit you. Converting to a Roth IRA could be a great strategy, but understanding if and when you should move your traditional IRA to a Roth can be difficult. Please consult with your Schneider Downs Wealth Management Advisor to see if this form of financial planning will work for you.
Material discussed is meant for general illustration and/or informational purposes only and it is not to be construed as investment, tax or legal advice. Although the information has been gathered from sources believed to be reliable, please note that individual situations can vary. Therefore, the information should be relied upon when coordinated with individual professional advice.