Roth IRA Conversions: When is the Best Time?
What would you like to know
- The conditions are currently in place for Roth conversions.
- Clients must fund the tax payable with non-IRA funds.
- Keep in mind that a client’s tax bracket could be much lower in retirement.
While establishing a source of tax-free retirement income is generally a smart game for any client, some clients will benefit more significantly from a Roth IRA conversion strategy – and timing is important.
Given the current political climate, there’s a good chance this year will be a prime time for customers to maximize the benefits of Roth conversions. Realistically, we’re pretty sure to see some sort of income tax hike in 2022 – if not sooner – and with the economy rebounding on hopes of vaccine effectiveness, lucky customers might even see. an increase in their income in the coming months.
The conditions are right now for Roth conversions – and clients need to be educated on who can benefit the most from the Roth conversion strategy to avoid missing out once this unique window is closed.
Reasons to consider a Roth conversion strategy in 2021
As most clients know, Roth IRA funds grow tax-free and are withdrawn tax-free during retirement. However, only clients with income below certain thresholds can pay after-tax funds directly to a Roth. Higher income clients can fund a Roth by converting traditional IRA funds (usually paid before tax) and paying tax on the converted amounts in the year of the conversion.
Currently, income tax rates are at historically low levels under the 2017 tax reform legislation. Almost all of Biden’s pending proposals involve raising the top tax bracket to previous levels. reform, which means customers will pay more tax on the conversion if (and when) these proposals become law.
Despite this, customers should carefully assess their personal financial situation before making a conversion. It’s important to consider both the current financial landscape and potential future changes in the customer’s circumstances that could impact the value of a conversion today.
Practical considerations when considering a Roth conversion
A source of tax-free income should be part of any well-diversified portfolio. It is impossible for anyone to predict the future with 100% accuracy. Tax rates may increase or the client may need additional funds during retirement. A Roth IRA provides a source of tax-free income to allow clients to control their taxable income later in life to avoid jumping into a higher tax bracket due to unexpected financial need during retirement.
Customers who anticipate higher tax rates or expect to be in a higher tax bracket in the future can minimize their tax liability by converting now. This way, they can pay taxes at the lowest current rates, freeing up more funds for additional retirement savings.
On a related note, it is always best to fund tax payable with non-IRA funds. Clients who have to rely on IRA funds to pay taxes on a Roth conversion essentially pay taxes on the converted funds that they use to pay taxes.