Is Now the Time for Roth IRA conversions?

Alfred E. Neuman: "Today, it takes more brains and effort to make out the income-tax form than it does to make the income."

The discussion on Roth IRAs is once again heating up and is centered on the timeliness of Roth IRA conversions. But not only because of the anticipated tax rate increases. Now is also a good time for Roth IRA conversions due to recent market declines. As you may have heard, we are heading into bear market territory with a possible recession looming.

Is this the cheapest time to do Roth IRA conversions? And do conversions make sense for you whether timing makes sense or not?

Let’s start with a quick refresher of why Roth IRAs are a hot topic. Roth IRAs provide tax benefits that no other retirement asset account can provide. That’s because you pay taxes on contributions to a Roth IRA. If setup and managed in accordance with IRS guidelines, you pay NO taxes on any money distributed from your Roth IRA after the age of 59 1/2. HUGE tax savings if you start early on a Roth IRA. And one less retirement risk to worry about if using Roth IRAs as part of your retirement strategy.

What is a Roth IRA conversion? This is where you convert moneys and/or securities from your Traditional IRA to a Roth IRA. Sounds simple, right? Just setup a Roth IRA and transfer funds to the Roth IRA from your Traditional IRA. Voila – tax free money! Well not so fast. Let’s talk logistics.

On amounts you convert from a Traditional IRA to a Roth IRA, you will have to pay taxes on the amount converted at the time of conversion.

If you are 59 ½ years old or older, you can use funds in your Traditional IRA to pay the taxes on the amount converted to a Roth IRA. If you are younger than 59 ½ years old, you either need to have funds set aside in a non-retirement account to pay the taxes upon conversion or pay a 10% penalty in addition to taxes owed on the amount converted.

And then it becomes about math. And a lot of speculating about what tax rates will increase to in the future. Experts are saying to expect tax rates to double by 2030. And when financial advisors are quoting tax savings to you in retirement, they are doubling your current tax rate to come up with the amount of tax savings. Will tax rates double by 2030? If no, how much will tax rates go up and when? Does anyone really know?

So, it may not benefit you to do a Roth IRA conversion if younger than 59 ½ years old and you don’t have extra cash sitting aside to pay the taxes on the amount converted. Now are their exceptions? Yep. But too much to discuss here. Contact me if you want to learn more about your options for tax-free funds in retirement.

Additional factors to consider are your current tax bracket and how much room you have in that tax bracket to convert without bumping you into the next tax bracket. Or even how much room you have for Roth IRA conversions if you do bump up into the next tax bracket.

What about the total amount in your Traditional IRA available for conversion? If you have $1 million or less in your taxable retirement accounts, maybe converting to a Roth IRA does not make economic sense for you. Even if you have more than $1 million in your taxable retirement accounts, it may not make sense for you to convert depending on how close to retirement you are or whether you are already in retirement. Although, legacy planning is an instrumental piece of the decision-making process regardless of age. As you can see, not as easy of a decision as you may have anticipated.

Rather than making a quick decision on Roth IRA conversions based on the fear of tax rates doubling in the next decade, put some logic and even some math behind your decision making. Bear in mind that this article is providing generalized information on Roth IRA conversions. If you are interested in more detailed information on Roth IRA conversions, consult your tax accountant and financial advisor.

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All information provided by Hartmann CFO, LLC and Healthy in Retirement is intended for informational purposes only. The views expressed are personal opinions and should not be construed as financial or tax advice for your specific situation. Please make sure to do your own research or find a trusted financial professional, tax adviser or attorney before making any financial decision on your own.

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