As the year winds down and we await the arrival of a new Congress, now may be the ideal time to review your retirement savings and consider converting some of your conventional IRA funds into a Roth IRA. While financial decisions like this should always be made with care and consultation with your financial advisor, many experts believe this could be a strategic move, given the current tax environment.
A Roth IRA conversion involves transferring funds from a traditional IRA to a Roth IRA. In a traditional IRA, your contributions are tax-deductible, but when you withdraw the funds during retirement, you’ll owe income tax on the withdrawals. In a Roth IRA, contributions are made with after-tax dollars, meaning withdrawals during retirement are generally tax-free, provided certain conditions are met. Converting your traditional IRA to a Roth IRA means you’ll pay taxes on the funds now, but you’ll enjoy tax-free withdrawals later.
The most compelling reason to consider a Roth conversion before the new Congress convenes is simple: tax certainty. Tax rates today are known quantities and for many individuals, they are lower than they’ve been in previous years. The Tax Cuts and Jobs Act, passed in 2017, brought lower tax rates that are set to expire after 2025, unless Congress acts to extend them. With a new Congress on the horizon, there’s uncertainty about what will happen to tax laws in the future.
Many financial experts believe it is unlikely that tax rates will get much lower than they are today. In fact, there is widespread speculation that rates could rise in the coming years to address the national debt and other budgetary needs. By converting to a Roth IRA now, you lock in today’s tax rates rather than risking higher taxes on your retirement withdrawals later.
A Roth conversion isn’t for everyone, but it can be particularly beneficial for individuals who:
▪ Expect to be in a higher tax bracket in the future. If you believe your tax rate will increase, either due to rising income or changes in the tax code, paying taxes now at a lower rate could save you money over the long term.
▪ Want to reduce their taxable income in retirement. With a Roth IRA, you won’t owe taxes on qualified withdrawals, which can help you better manage your income in retirement and potentially reduce taxes on Social Security benefits or Medicare premiums.
▪ Prefer tax-free inheritance for their heirs. Roth IRAs are not subject to required minimum distributions (RMDs) during your lifetime, allowing the account to grow tax-free for as long as you don’t need the money. Plus, your heirs can inherit the account tax-free as well.
While a Roth conversion can offer long-term tax advantages, there are a few things to consider before making the move.
Tax Bill: When you convert, you’ll owe taxes on the amount you move from your Traditional IRA to a Roth IRA. If you convert a large amount, this could bump you into a higher tax bracket for the year. It’s generally advisable to use cash from outside the IRA to pay the taxes, so you don’t reduce your retirement savings.
Timing: The timing of the conversion is key. Converting in a year when your income is lower can help minimize the tax impact. If you expect a bonus or other large income, you may want to plan your conversion around those events.
Consult Your Advisor: Before making any decisions, it’s important to consult with your financial advisor or tax professional. They can help you evaluate your situation and determine the most tax-efficient strategy for your Roth IRA conversion.
With tax rates at historically low levels and the uncertainty of future tax policy, now could be an opportune time to consider converting some of your Traditional IRA dollars to a Roth IRA. This decision requires careful planning and an understanding of your long-term financial goals, but for those looking to take advantage of today’s known tax environment, it could offer substantial benefits down the road.
Rodney M Loesch CFP CDFA is a Senior Partner at LifeGoals Strategies Group in Lee’s Summit, and a member of the Financial Planning Association of Greater Kansas City. He offers securities and advisory services thorough LPL Financial, a registered investment advisor, member FINRA/SIPC.
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