A Roth IRA is a beneficial tool when it comes to retirement savings. In a perfect world, retirees should have 100% of their money in Roth accounts because they are “after-tax” accounts. Having an after-tax account means you pay taxes prior to putting money in, so you do not have to pay taxes when you withdraw. Unfortunately, Roth accounts often aren’t taken advantage of enough because they can be confusing.
Money from pre-tax qualified accounts can be transferred into a Roth IRA. This process is a Roth Conversion, and there are a few questions to consider before taking this step.
Is the timing right?
There are two times I recommend a Roth Conversion:
1. End of the Year: It’s wise to consider a Roth Conversion in December, when you can take the events of the entire year into account.
Events in Washington: Waiting until year-end minimizes legislative risk. You can consider any new laws that are passed that could impact whether the timing is right for you.
Life events: Any big financial swings, like a medical emergency or a downpayment on anew home, could shift you into a different tax bracket. Doing a Roth Conversion early in the year can limit your options.
2. During a Market Decline: When the market is in a pullback that you believe to be temporary, you can buy in at the bottom, convert to a Roth IRA and watch the growth. Imagine making this move in March of 2020 when the Dow Jones dropped 37% only to quickly rebound!
Can I cover the taxes?
Anyone under age 59 1/2 will have to pay a 10% excise penalty on the money they convert to a Roth IRA. We are in the most efficient tax window in history right now, which is scheduled to sunset at the end of 2025. We are advising clients to take advantage of these tax breaks, as long as they have the funds to cover the tax hit.
How does this impact my overall tax plan?
You can do a Roth Conversion on your own--just sign a form, indicate the amount and you’re done. But, I don’t recommend it.
There are potential pitfalls you may not be aware of--you may be subject to the Net Income Investment Tax or your Medicare costs could be penalized when you cross a certain income threshold. These are things you may not realize unless you are taking your overall tax plan into account.
At Asset Preservation Tax & Retirement Services, we have a tax office so we can tax plan. We use real tax software that looks at all of the implications of a Roth Conversion so we can see all of the effects. This eliminates the guesswork and gives clients peace of mind.
The future is unpredictable. A number of factors--booming inflation, rising oil and gas prices and the war in Ukraine--could signal instability on the horizon. At Asset Preservation Tax &Retirement, we’ll be watching for opportunities a stock market decline could present. “Drop”--much like “Roth”--isn’t necessarily a four-letter word
Stewart Willis is the founder and president of Asset Preservation Wealth & Tax, a financial planning firm in Phoenix, Arizona. Investment advisory services offered through Foundations Investment Advisors, LLC, an SEC registered investment adviser.