Why doing a Roth right now may be bestSubmitted by Financial Planning Solutions, LLC on May 16th, 2019
Roth IRAs have become a great vehicle for managing your current and future tax situation. It can also be a helpful estate planning tool. But for many upper-middle income investors, contributing to a Roth IRA is not an option. Once your income exceeds $137,000 (single filers) or $203,000 (married filing jointly), you cannot contribute to a Roth IRA.
Nevertheless, you can still convert a Traditional IRA or 401(k) to a Roth, regardless of income. Many investors are starting to look at this option, especially now that personal income tax rates have dropped with the Tax Cuts and Jobs Act (TCJA) of 2018.
For taxpayers who were formally in the top personal income tax bracket of 39.6%, they are now paying 37%. This has helped many to reduce the cost of Roth conversions. Keep in mind that the amount of the conversion in a given tax year is added to your taxable income, resulting in additional tax that you must pay.
Why might converting to a Roth matter now?
With the passage of the TCJA, lower personal income tax rates were not made permanent. Unless Congress acts, the current, lower rates will expire on December 31, 2025. That means we’ll go back to the old, higher rates in the not too distant future.
Bottom line: If tax rates are low now and expected to be higher later, a Roth conversion may make sense, even for higher income individuals.
Let’s use the hypothetical married couple of Cindy & Karl Jones who currently have joint income of $300,000. Their income is above the Roth phase out contribution limit. At this level, they are in the 24% marginal federal tax bracket. If the brackets and tax rates revert to the old brackets in 2026, they will return to the 33% tax bracket.
Let’s compare a $10,000 Roth conversion for Cindy & Karl now vs. in 2026 when their tax rate is likely to be higher:
Convert now: $2,400 additional tax bill
Convert in 2026: $3,300 additional tax bill
Potential tax savings by converting now: $900
Why did I use only $10,000?
Conversions can be costly, especially if you convert 100% of a large IRA rollover account. And, large conversions can push you into a higher tax bracket, which can defeat the purpose of this strategy.
But smaller conversions that are done over a period of years may help ease the tax bite and allow you to shift more assets into an account that will never be subject to taxation as long as you make qualified distributions.1
In this example, Cindy & Karl could convert over $60,000 by converting $10,000 every year. That’s $60,000 that will not be subject to taxation in the future and it will also no longer be subject to required minimum distributions that begin at age 70½. As with any tax strategy, please consult your tax professional before implementing it.
Are you wondering if a Roth conversion would make sense for you? Give us a call. We’re here to help.
Lyman H. Jackson
1 Roth IRA/401(k) conversions have several special rules. Roth IRAs must remain open for five years before you can make a qualified withdrawal that is not subject to the 10% penalty tax. In addition, this discussion is based on current tax laws; if tax laws and rates change, this strategy may not be advantageous.
Financial Planning Solutions, LLC (FPS) is a Registered Investment Advisor. FPS provides this blog for informational and educational purposes only. Nothing in this blog should be considered investment, tax, or legal advice. FPS only renders personalized advice to each client after entering into an advisory relationship. Information herein includes opinions and forward-looking statements that may not come to pass. Information is derived from sources believed to be reliable. Information is at a point in time and subject to change without notice. Such information may not be independently verified by FPS. Please see important disclosures link at the bottom of this page.