Should You Convert Your IRA to a Roth in 2020?Submitted by Reby Advisors | Certified Financial Planners | Danbury, CT on July 23rd, 2020
By Patrick Doherty, CFP®, July 24, 2020
“In this world nothing can be said to be certain, except death and taxes.”
Two hundred thirty years later, Benjamin Franklin’s words remain true. Uncle Sam will get a share of your money. When and how much are the only uncertainties.
Fortunately, Uncle Sam gives preferential treatment to Americans who save for retirement in IRA accounts, offering valuable tax breaks and options that give you some control over when you pay taxes and even how much.
This article and the video clips below are about making the right decisions regarding IRA accounts, Roth Conversions, and the tax consequences of your choices.
Traditional IRA account or a Roth IRA?
For most people, the decision boils downs to two options: Get an immediate tax deduction when you contribute money to a Traditional IRA account or pay no taxes when you take withdrawals from a Roth IRA after age 59½.
At the expense of oversimplifying: Taxes later (Traditional IRA) or Taxes now (Roth IRA).
2020 May Be the Ideal Year for a Roth Conversion
Uncle Sam allows you to convert funds in a Traditional IRA account into a Roth IRA, which is called a Roth Conversion.
In a recent webinar, I explained why 2020 may be the ideal year to execute a Roth Conversion for long-term tax savings and the benefit of your loved ones’ inheritance. Recent legislation and proposals in the early stages of the pipeline have made Roth Conversions more attractive. However, each individual's situation is different.
Below are the key considerations with video clips from the recent webinar:
Current vs. Future Income Tax Bracket
As my colleague Devone McLeod and I explained during the Q&A session at the end of the webinar, Roth Conversions make the most sense when your current tax rate is lower than it will be when you take withdrawals in the future.
Let’s say your marginal tax rate is 10% and you convert $20,000 of assets from a Traditional IRA to a Roth IRA. Because you’re transferring money from a “taxes later” IRA account to a “taxes now” Roth IRA, the value of the assets at the time of the Roth Conversion counts as income on your tax return.
In this example, you will owe $2,000 on this year’s tax return. The advantage, of course, is that future withdrawals from the Roth IRA account will not get taxed.
Was this Roth Conversion worth it? We could answer this question with mathematical certainty only if we knew what the future holds…
Certainty vs. Uncertainty
What will the United States tax code look like 5, 10, or 20 years from now? How much will your assets grow or decline in value during this timeframe? These answers ultimately determine whether a Roth Conversion was the right move.
Since we cannot predict the future with certainty, we must evaluate risks.
Are income taxes more likely to increase or decrease in the future?
Tax rates are at all-time lows for most Americans, and future tax increases would make a Roth Conversion in 2020 more attractive.
If tax rates go up, is your tax bracket likely increase dramatically?
If not, a Roth Conversion that moves you into a higher tax bracket in 2020 may not be worth it. Consider smaller annual Roth Conversions instead.
Do have legacy goals? How much money, after taxes, do you want your loved ones to inherit?
Leaving assets behind in a Traditional IRA or a Roth IRA can make a big difference to your beneficiaries...
Leaving a Tax-Free Inheritance
Roth Conversions add the most value to an estate plan in instances when IRA accounts are large and beneficiaries are high-income earners.
Loved ones who inherit a Roth IRA from you will not owe any taxes on withdrawals. The Roth is the “taxes now” option, but you already paid the taxes before depositing money into the account. The money does not get taxed again, not even when your children or grandchildren withdraw funds.
Taxes on withdrawals from inherited Traditional IRA accounts vary based on the beneficiary’s tax bracket and value of distributions during the tax year. Under the current tax code, high income earners will owe the federal government up to 37% of withdrawals. Then the state government takes its share.
Moreover, The SECURE Act mandates the withdrawal of all funds from an inherited Traditional IRA within 10 years. Depending on the value of the account, even low- and middle-income beneficiaries may end up paying a hefty share of their inheritances to the government.
Is a Roth Conversion Right for You?
If would like advice on Roth Conversions or investing for retirement, please do not hesitate to contact Reby Advisors. We would love to help.