Roth Conversions

AN OVERVIEW OF ROTH CONVERSIONS

A Roth conversion moves all or part of your traditional pretax IRA to a Roth IRA. Roth conversions are used as a tax planning strategy: accelerating income taxes due on the converted amount to create tax-free retirement account growth.* Generally, amounts converted will be subject to ordinary income tax in the year converted. If your traditional IRA has after-tax contributions, any distributions, including distributions as a result of a Roth conversion, will be subject to the pro rata rule. If after tax dollars are converted to a Roth, there is no tax liability on those dollars.

WHY CONSIDER A ROTH CONVERSION?

• Individuals may convert because they believe their tax bracket will be lower today than in the future.
• Current or expected taxable income in the current year is lower than future years.
• Pay taxes now so that beneficiaries can inherit from the Roth IRA tax free, if certain qualifications are met.
• The SECURE Act limited “stretch” provisions. Most non-spousal beneficiaries will have to take distributions of traditional IRAs over 10 years, recognizing more taxable income in a shorter period of time, which could in turn lead to higher taxes. A Roth IRA must still be distributed within 10 years. However, since qualified distributions from a Roth account are tax free, your beneficiaries can let the Roth account grow and then take the entire distribution in year 10 with no tax consequences.
• A Roth conversion is a planning opportunity to create tax-free income for beneficiaries. It may also be used if the beneficiary is, or plans to be, in a higher tax bracket than the IRA owner or when the account is distributed.
• Create tax diversification in retirement. Roth IRA distributions are generally tax-free, whereas traditional IRA distributions are taxable.
• Having some of each (taxable and tax-free) accounts allows retirees to adjust to future tax environments.
• Limit future required minimum distributions – RMDs – for tax bracket management. A Roth conversion will result in a smaller traditional IRA, which equates to lower RMDs.
• Roth IRA distributions do not increase modified adjusted gross income for Social Security or Medicare premiums.

POTENTIAL CONSIDERATIONS OF A ROTH CONVERSION

Implementing a Roth conversion means paying taxes now, which may not be beneficial if you are in a higher tax bracket today than you expect you will be in the future.

While there are many benefits of Roth conversions, they will increase your taxable income in the year of conversion. Aside from higher taxes, it may also affect other tax deductions, credits, and related items such as Medicare Premium surcharges.

A Roth conversion also isn’t beneficial if you need the distributions for immediate expenses.

Also, consider your beneficiaries. If you intend to leave your traditional IRA to a charity, it may not make sense to pay additional taxes today for money that the charity wouldn’t be taxed on upon receipt.

The decision to convert a Roth IRA and pay taxes now can be guided by multiple factors. You should consider it if you are in a low tax rate now but will be in a higher tax rate in the future. A Roth is also more advantageous if tax rates go up in the future. Other considerations could include tax diversified retirement savings as well as a tax-free gift to beneficiaries.

*In order for earnings to be tax free, converted funds must be held in the Roth IRA for five years and distributions must occur after age 59 1/2 or as a result of death, disability or first-time home purchase of $10,000.

RMDs are generally subject to federal income tax and may be subject to state taxes. Consult your tax advisor to assess your situation. Unless certain criteria are met, Roth IRA owners must be 59½ or older and have held the IRA for five years before tax-free withdrawals are permitted. Additionally, each converted amount may be subject to its own five-year holding period. Converting a traditional IRA into a Roth IRA has tax implications. Investors should consult a tax advisor before deciding to do a conversion.

Investing involves risk and you may incur a profit or loss regardless of strategy selected, including diversification and asset allocation. The foregoing information has been obtained from sources considered to be reliable, but we do not guarantee that it is accurate or complete, it is not a statement of all available data necessary for making an investment decision, and it does not constitute a recommendation. Any opinions are those of Troy Logan and not necessarily those of Raymond James.