“The stock market is down right now. Is this a good time to do a Roth conversion?” This was a regular question from clients in the last market decline.
A market downturn may be a good time to do a conversion from a Traditional IRA to a Roth IRA. However, there is more to consider in doing a conversion to a Roth IRA.
When will the money be needed?
Can you let the converted IRA grow for 10 years or more? A Roth conversion has a 5-year waiting period before it can be accessed without a penalty. You also want to allow time for the account to grow and recoup income taxes paid as a result of the conversion.
Do you have another source of income to live from? Are you still working? Do you have other accounts you can draw from for living expenses?
What will be the future tax rates?
Trillions of dollars are being borrowed to manage the crisis of the pandemic. How will that get paid back? Taxes are going up – it’s a matter of when and how much.
If you are in a higher tax rate at this time, a Roth conversion would create additional taxes. It could also expose you to phase out levels for deductions and the net investment tax.
However, if your current taxable income doesn’t absorb the full range of the 12% tax bracket, you may consider a Roth conversion. For a married couple the top of 12% tax bracket is at $81,050. For a single taxpayer it is $40,525.
In 2021, the Johnsons have taxable income of $50,000. They can convert $30,000 of a Traditional IRA and remain in the 12% tax bracket.
George really likes the benefits of having a Roth IRA, but his taxable income is in the 22% tax range. Should he convert some of his retirement account and max out his 22% tax bracket?
It depends. Do you think your tax rate will be higher in the future? How strongly do you feel about a tax-free Roth account?
Also be aware if you are on Medicare, your income can impact your premiums. To maintain base premium cost for 2021 of $148.50, a married couple’s modified adjusted gross income needs to be below $176,000 in 2019. For single filer’s the amount is $88,000 or less. As your modified adjusted gross income goes up, so does your Medicare premium.
How will you pay the additional taxes created by the conversion?
Do you have money available to pay the tax from the conversion? It is best to pay the tax from non-retirement accounts. This is especially true if you are under 59½, you could be subject to a 10% penalty tax.
For example, a 58-year-old chooses to convert $50,000 from a Traditional IRA to a Roth IRA. You have the fund company withhold 12% or $6,000 to cover the taxes. If the $6,000 isn’t replaced, it will be subject to a 10% penalty for early distribution. Or another $600 of taxes.
In the past, I have been reluctant to do Roth conversions, if I didn’t see a significant tax rate difference from the current situation to future tax rates. But when the SECURE ACT passed in 2019, I became a believer in Roth conversions.
The SECURE ACT was the death of the Stretch IRA. You can no longer pay out the Inherited IRA over the beneficiaries’ lifetime. Instead, the assets have to be ALL paid out of the Inherited IRA within 10 years.
Depending on the beneficiary and the size of your IRA, you may have just handed your loved one a boat anchor of taxes.
An Inherited Roth IRA still has to pay out to a non-spouse beneficiary (your child/grandchild) in 10 years, but it doesn’t come with a tax bill.
Roth conversions may be a planning tool for you. You may do partial conversions over several years to minimize the tax and other impacts.
Our office is here to assist you with this evaluation. We will partner with your tax preparer in this calculation.