What is a Roth Conversion?
Roth conversions are a strategy that allows savers to decrease their tax burden in retirement. A Roth conversion is when an investor converts a traditional retirement account into a Roth retirement account. Traditional and Roth are terms the IRS uses to distinguish tax status for retirement accounts.
Why do this ?
If you have accumulated a healthy nest egg in a traditional retirement account, when retirement comes distributions from the account will be taxed at whatever tax rate you happen to be in at that time. With a ROTH, distributions after age 59 ½ are tax-free. If you are tired of paying taxes and want to put some of your taxes behind you, this can be a huge benefit.
As their name suggests, they are required distributions that must be taken annually. Roth IRAs are not subject to RMDs. Additionally, as long as you earn income you can contribute to a Roth IRA after age 70 ½. Having a Roth account in your financial plan creates more longevity.
What are the conversion rules?
If you are an individual with a modified adjusted gross income (MAGI) over $203,000 or a married couple filing jointly with a MAGI over $137,000 you are unable to contribute to a Roth IRA. However you are able to convert Traditional accounts to Roth accounts.
The assets coming from the traditional retirement account will be subject to regular income tax in the year the conversion occurs. This requires planning and liquidity to pay the taxes.
Why are we talking to our clients about this?
If you watch the news you are hearing the shifting rhetoric about taxes coming from Washington. The country’s budget deficit climbs higher every year. Social Security and other entitlements are already underfunded and growing. Many state’s pension plans are underfunded and it is getting more competitive for states to attract businesses to pay taxes and support these shortfalls. While we don’t know when taxes will increase, we do believe the current tax rates are likely lower than future tax rates. This makes doing a Roth conversion now more attractive than not doing one or waiting to do one later.
In addition to the tax rates, we expect the capital markets to remain volatile this year. Markets are very sensitive to news about trade deals with China, Brexit, potential Government Shutdown and interest rate changes. Often times investors overreact to such news creating short-term selloffs despite strong underlying fundamentals. Volatile markets create opportunities to convert depreciated assets since the taxes due are less than on appreciated assets.
Is a Roth Conversion Right For You?
We are firm believers in the benefits of moving to Roth accounts. However, Roth conversions are a complex maneuver. With variables constantly changing such as income, tax rates and personal liquidity. If you are considering a partial or full conversion of a traditional retirement account, we recommend you speak with a trusted advisor. At Pleasant Street Wealth Advisors our integrated Financial Planning team has the knowledge and experience to guide you through all of your options.
Roadmap to Retirement – Webinar
Tuesday, March 16th, 2021 at 12 PM via Zoom