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Roth conversions on sale

April 15, 2020 by The Trust Company of Tennessee

Chances are your IRA has a lower market value today than it did at the start of the year. No matter your age or retirement timeframe, this can be a hard pill to swallow. While the current market environment may only seem to bring negative thoughts of retirement to mind, there may be a silver lining to those who choose to take a long-term perspective in the midst of uncertainty. In fact, we would challenge you to view the market today as if everything were on sale, including Roth Conversions.

Generally, when converting money to Roth, you want to be in a lower tax bracket during the years you’re converting money than you would be down the road when you’re withdrawing money. This is because Roth IRA’s grow tax-free, so taking advantage of lower tax brackets during certain stages of life means paying less in tax over time. For some, this could be in retirement before Required Minimum Distributions (RMD’s) kick in at age 72. In addition, while there are limits to how much you can contribute to a Roth IRA in a single year, there are no limits to how much can be converted in a single year. Given recent tax law changes and the current market environment, there may be even more reason now to convert retirement assets to a Roth IRA.

  • Lower Market Values – more than likely, your retirement balance is lower today than it was at the start of year. By choosing to convert some portion of your tax-deferred IRA to Roth, you’re converting less money than you would have at the start of the year. The less money you convert, the less you’ll be paying in taxes on the conversion and you’ll be taking advantage of the tax-free growth in the Roth IRA as the market returns to normal over time. In turn, making Roth Conversions “on sale”.
  • Historically low taxes – with provisions in The Tax Cuts and Jobs Act (TCJA) of 2017 to significantly increase the standard deduction and lower individual income tax brackets, you may have more room to convert funds to a Roth IRA than realized. Furthermore, these favorable provisions are only promised for 5 more years, as the TCJA is set to sunset December 31, 2025 (unless made permanent which is unlikely). Providing more reason to take advantage of the tax law changes now.
  • Legacy Planning – with the SECURE Act passing at the end of 2019, leaving traditional IRA’s to your heirs may no longer be attractive. With the new rules, an Inherited Traditional IRA left to your child would have to be paid out in 10 years. That could mean significant taxes being paid by your loved ones in the 10 years following your death. Compound that with sizeable assets and high-earning beneficiaries, this can result in an even bigger tax blow to your loved ones.If leaving money to heirs is important, a Roth IRA is a far better vehicle to leave behind than a Traditional IRA because of tax-free growth. While an Inherited Roth IRA would still have to be liquidated within 10 years after death, your beneficiaries could allow the Roth to continue to grow and then liquidate in year 10 with no tax consequences.
  • Longer Time Horizon – now that RMD’s do not have to be taken until age 72, thanks to the SECURE Act, the average retiree age 65 may have 7 years of being in a potentially lower tax bracket before their RMD’s kick in and possibly bump them into the next bracket. Taking advantage of this time frame by converting assets can help spread out the tax liability and prove to ultimately save tax dollars in the long run if done right.

If you decide to move forward with converting money to Roth, there are few things to keep in mind.

  • Any contributions or conversions should be tracked using the Form 8606. Be sure to consult your tax advisor before converting money to Roth.
  • The IRS requires a waiting period of 5 years before you can withdraw converted balances. This rule is separate from the 5-year rule related to contributions to a Roth IRA.
  • A conversion to Roth cannot be recharacterized. Understand your tax liability before converting.

To learn more about Roth Conversions and whether this could be a beneficial strategy for you, reach out to a Relationship Manager at The Trust Company of Tennessee.

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