If you have a tax-deferred account, you must begin taking required minimum distributions at age 72. Those distributions—even if you don’t need the money—can push you into a higher tax bracket or force you to pay higher Medicare premiums. By contrast, withdrawals from a Roth aren’t taxed and you won’t have any required distributions. It is a tax-free money bucket that you can tap whenever needed or leave as a legacy.
There have been opportunities for Roth conversions this year. Investors could have taken advantage of the pandemic-induced market decline this spring to do big Roth conversions and pay less tax on reduced asset values.
In addition, Congress tightened the rules for inheriting tax-deferred assets. Whereas in the past, beneficiaries could empty a tax-deferred account over their lifetime, now most non-spouse beneficiaries have only 10 years to do so. That will mean steep tax bills for many people inheriting tax-deferred accounts, particularly for high earners already in a high tax bracket.
There’s a strong incentive to get money out of a traditional IRA into a Roth so it’s not a time bomb blowing up for people. In the example of the retired educator, she hopes to leave the entire Roth account to her children. She plans to live off other savings and distributions from the remaining money in her tax-deferred account, which is conservatively invested—80% in bond funds. Meanwhile, her Roth account is aggressively invested—80% in stock mutual funds, to maximize its growth.
In a Roth conversion, pretax dollars are converted to after-tax dollars. In the simplest type, an in-kind conversion, you work with our team to identify that you want to convert, say $50,000 of mutual fund shares, from your tax-deferred account to your Roth account on a particular day.
When you file your taxes next year, the value of the investments the day you converted is treated as ordinary income.
Regardless of market conditions, Roth conversions can be particularly enticing to certain investors. For instance, seniors with low taxable income but bulging tax-deferred accounts might consider doing them every year before they hit age 72 and begin required minimum distributions, which can push them into a higher tax bracket.
Roth conversions don’t make sense for everyone. People who expect their future tax rates to be lower than they are now are generally better off leaving the money in a tax-deferred account. Others may be planning to leave their tax-deferred account to a child with a low tax rate.
We will team up with you and your tax professional to take a careful look at your entire financial picture before deciding to go ahead with a Roth. We don't believe in a one size fits all approach.
If you would like to know if a Roth conversion might make sense for your situation, let's visit!