Tax-Smart Strategies: Why Consider a Roth IRA Conversion Now?
Converting all or part of your pre-tax retirement account to a Roth IRA can be a big decision with potentially significant tax consequences. In this blog post, which is part of a four-article series on tax-smart strategies, we will look at why—and when—it might make sense for you to make such a conversion.
A Roth IRA conversion involves the transfer of assets from a traditional IRA, a simplified employee pension (SEP), a SIMPLE IRA or a defined-contribution plan—such as a 401(k)—into a Roth IRA. Although you’ll need to pay income tax on the money you transfer, any future growth of those assets within the Roth IRA will be tax-free, as will any future withdrawals, assuming compliance with the five-year rule.1
In our view, the main reason to consider converting your plan is that you would prefer to pay tax now rather than later. From a timing perspective, you might find that the advantages are more compelling based on one or more of the following: you’re in a certain tax bracket; you’ve reached a particular age or life milestone; a specific tax rule change is expected; or opportunities have arisen from recent market activity.
Why might now be a good time to consider a Roth IRA conversion? Here are a few factors that you might wish to discuss with your Corient Wealth Advisor.
Converting to take advantage of market timing
Let’s assume that certain markets you invest in have been struggling, and the value of their securities continues to decline. If you and your Corient Wealth Advisor see a compelling opportunity to convert to a Roth IRA now, you may wish to take advantage of the situation.
For two reasons, this could create interesting timing for converting traditional IRA assets to a Roth IRA account. The first reason is that, since the value of the underlying assets could be lower given a market decline, the amount of taxes owed could decrease. The second reason is that the future recovery in the value of your portfolio, assuming that markets will rebound, will be tax-free within the Roth IRA.
Converting to benefit from lower tax rates
The 2017 Tax Cuts and Jobs Act lowered income tax rates across the board. However, these lower rates will sunset after 2025, which will make Roth IRA conversions more expensive.2 It could be beneficial to take advantage of the current lower rates while they are still around.
Converting to “prepay” estate and income tax
Depending on your situation, a Roth IRA conversion may be beneficial to reduce estate taxes and effectively prepay income taxes for your heirs. Here’s how it works.
If you were to pass away while owning a traditional IRA, your estate could owe tax on the value of the account, and your heirs could owe tax on any withdrawals they made. Doing a Roth IRA conversion means paying tax on the account value now so that neither your estate nor your heirs will owe any further income taxes.
When considering a Roth IRA conversion for estate tax purposes, two variables to take into account are your current tax rate versus the anticipated tax rate of your heirs and the potential impact of state taxes.3 For example, if your heirs live in a state that taxes traditional IRA withdrawals, this might argue more strongly in favor of doing a conversion.
Other considerations regarding a Roth conversion
The amount you convert to a Roth IRA is treated as ordinary income. This is important because it could have the effect of pushing other types of income, such as qualified dividends and capital gains that typically attract less tax, into higher tax brackets.4 Also, be aware that moving into a higher income bracket could have consequences for someone who is on Medicare.5 For both of these reasons, it’s wise to consider all of the potential ripple effects before following through with a Roth IRA conversion.
Whether a Roth IRA conversion is right for you—and whether now is truly the best timing—depends on numerous individual factors and other objectives. But if you see yourself in any of the scenarios presented here, it might be time to discuss with your Corient Wealth Advisor.
Other articles in this series
- Are You Maximizing Tax-Advantaged Accounts?
- Is Now a Good Time to Give Financial Gifts?
- Can You Take Advantage of Tax-Loss Harvesting?
1 https://www.investopedia.com/ask/answers/05/waitingperiodroth.asp
2 https://www.law.cornell.edu/wex/tax_cuts_and_jobs_act_of_2017_(tcja)
3 https://www.investopedia.com/articles/managing-wealth/090816/inherited-ira-distributions-and-taxes-getting-it-right.asp
4 https://www.irs.gov/retirement-plans/retirement-plans-faqs-regarding-iras#Distributions%20(Withdrawals)
5 https://www.medicare.gov/Pubs/pdf/11579-medicare-costs.pdf
ABOUT THE AUTHOR
Matt Foltz, CPA, CFP, CEPA, MS in Accountancy
Matt is an Associate Partner, Wealth Advisor in our Itasca, IL, office. He also serves on the Investments team. Previously, Matt worked at legacy firm BDF, where he sat on the firm’s Financial Planning Committee and led many of the firm’s tax-related initiatives. He has a passion for building strong relationships with his clients and helping them make sound decisions. Matt holds the Certified Exit Planning Advisor® designation, which helps him advise business owners on how to exit their business and prepare for retirement.
CONTENT DISCLOSURE
This information is for educational purposes and is not intended to provide, and should not be relied upon for, accounting, legal, tax, insurance, or investment advice. This does not constitute an offer to provide any services, nor a solicitation to purchase securities. The contents are not intended to be advice tailored to any particular person or situation. We believe the information provided is accurate and reliable, but do not warrant it as to completeness or accuracy. This information may include opinions or forecasts, including investment strategies and economic and market conditions; however, there is no guarantee that such opinions or forecasts will prove to be correct, and they also may change without notice. We encourage you to speak with a qualified professional regarding your scenario and the then-current applicable laws and rules.
Advisory services are offered through Corient Private Wealth LLC and its affiliates, each being a registered investment adviser (“RIA”) regulated by the U.S. Securities and Exchange Commission (“SEC”). The advisory services are only offered in jurisdictions where the RIA is appropriately registered. The use of the term “registered” does not imply any particular level of skill or training and does not imply any approval by the SEC. For a complete discussion of the scope of advisory services offered, fees, and other disclosures, please review the RIA’s Disclosure Brochure (Form ADV Part 2A) and Form CRS, available upon request from the RIA and online at https://adviserinfo.sec.gov/. We also encourage you to review the RIA’s Privacy Policy and Code of Ethics, which are available upon request.
Our clients must, in writing, advise us of personal, financial, or investment objective changes and any restrictions desired on our services so that we may re-evaluate any previous recommendations and adjust our advisory services as needed. For current clients, please advise us immediately if you are not receiving monthly account statements from your custodian. We encourage you to compare your custodial statements to any information we provide to you.
