Roth IRA Conversions
What are your choices? What are the benefits?

Provided by Marc Aarons

If you own an Individual Retirement Account (IRA), perhaps you have heard about Roth IRA conversions. Converting your traditional IRA to a Roth IRA might be a sound financial move depending on your situation.

But remember, this article is for informational purposes only, not a replacement for real-life advice. A professional should be consulted before attempting this type of strategy. Tax rules are constantly changing, and there is no guarantee that the tax treatment of Roth or Traditional IRAs will remain the same as it is now.

Also, Roth conversions have come under much scrutiny during the past few years. Congress has considered legislation that would prevent high-income Americans from Roth conversions. While no action has taken place, it is possible that Roth rules may change in the future.

Why go Roth? Every Roth IRA conversion is based on a belief: the belief that income tax rates will be higher in the future than they are now. If you hold this belief, then you may want to consider a Roth conversion.

Once you are 59½ and have had your Roth IRA open for at least five calendar years, withdrawals of the earnings from your Roth IRA are exempt from federal income taxes. In addition, once five calendar years have passed, you can withdraw your Roth IRA contributions tax-free and penalty-free.¹

Under current I.R.S. rules, if you are the original owner of a Roth IRA, you never have to make mandatory withdrawals from your account. And you can make contributions to a Roth IRA as long as you continue to have earned imcome.²

Currently, if your federal tax filing status is married filing jointly and your adjusted gross income (AGI) is $204,000 or less, you can contribute a maximum of $6,000 to your Roth IRA, $7,000 if you’re age 50 or older. The maximum contribution is also available to single filers with an AGI of $129,000 or less. Depending on how high your AGI is, the amount you are able to contribute may change.³

Why not go Roth? There are many reasons, but here are two to consider: you have to be prepared for the taxable event and time may not be on your side.

A Roth IRA conversion cannot be undone. The I.R.S. regards it as a payout from a traditional IRA prior to that money entering a Roth IRA, and the payout represents taxable income. That taxable income stemming from the conversion could have tax consequences in the year when the conversion occurs.⁴

In many respects, the earlier in life you convert a regular IRA to a Roth, the better. Your income may rise as you get older; you could finish your career in a higher tax bracket than you were in when you were first employed. Those conditions relate to a key argument for going Roth: it is better to pay taxes on IRA contributions today than on IRA withdrawals tomorrow.

On the other hand, since many retirees have lower income levels than their end salaries, they may retire at a lower tax rate. That is a key argument against Roth conversion.

You could choose to “have it both ways.” As no one can reliably predict the future of American taxation, some people contribute to both Roth and traditional IRAs – figuring that they can be at least “half right” regardless of whether taxes increase or decrease.

If you do go Roth, your heirs may receive tax-free distributions. Lastly, Roth IRAs can prove to be very useful estate management tools. If I.R.S. rules are followed, Roth IRA heirs may end up with a tax-free inheritance from the account. In contrast, distributions of inherited assets from a traditional IRA are taxed.¹

Under the 2019 SECURE Act, most non-spouse beneficiaries of a Roth IRA are required to have the funds distributed to them by the end of the tenth calendar year following the year of the original owner’s death.⁵

Marc Aarons may be reached at 714-887-8000 or marc@ocmoneymanagers.com.

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MMI Disclosure: This material was prepared by MarketingPro, Inc., and does not necessarily represent the views of the presenting party, nor their affiliates. This information has been derived from sources believed to be accurate. Please note – investing involves risk, and past performance is no guarantee of future results. The publisher is not engaged in rendering legal, accounting or other professional services. If assistance is needed, the reader is advised to engage the services of a competent professional. This information should not be construed as investment, tax or legal advice and may not be relied on for the purpose of avoiding any Federal tax penalty. This is neither a solicitation nor recommendation to purchase or sell any investment or insurance product or service, and should not be relied upon as such. All indices are unmanaged and are not illustrative of any particular investment.

^Citations

^{1 – U.S. News, January 27, 2022}

^{2 – Internal Revenue Service, November 27, 2021}

^{3 – Internal Revenue Service, November 5, 2021}

^{4 – Investopedia, February 2, 2022}

^{5 – Forbes, December 14, 2021}

The post Roth IRA Conversions appeared first on Money Managers, Inc..

A move that high earners can make in pursuit of tax-free retirement income.
Provided by Marc Aarons @ Money Managers, Inc.

Does your high income stop you from contributing to a Roth IRA? It does not necessarily prohibit you from having one. You may be able to create a backdoor Roth IRA and give yourself the potential for a tax-free income stream in retirement.

If you think you will be in a high tax bracket when you retire, a tax-free income stream is just what you want. The backdoor Roth IRA is a maneuver you can make in pursuit of that goal – a perfectly legal workaround, its legitimacy further affirmed by language in the Tax Cuts & Jobs Act of 2017.¹

You establish a backdoor Roth IRA in two steps. The first step: make a non-deductible contribution to a traditional IRA. (In other words, you contribute after-tax dollars to it, as you would to a Roth retirement account.)¹

The second step: convert that traditional IRA to a Roth IRA or transfer the traditional IRA balance to a Roth. A trustee-to-trustee transfer may be the easiest way to do this – the funds simply move from the financial institution serving as custodian of the traditional IRA to the one serving as custodian of the Roth IRA. (The destination Roth IRA can even be a Roth IRA you used to contribute to when your income was lower.) Subsequently, you report the conversion to the Internal Revenue Service using Form 8606.^1,2

When you have owned your Roth IRA for five years and are 59½ or older, you can withdraw its earnings, tax free. You may not be able to make contributions to your Roth IRA because of your income level, but you will never have to draw the account down because original owners of Roth IRAs never have to make mandatory withdrawals from their accounts by a certain age (unlike original owners of traditional IRAs).^1,3

You may be wondering: why would any pre-retiree dismiss this chance to go Roth? It comes down to one word: taxes.

The amount of the conversion is subject to income tax. If you are funding a brand-new traditional IRA with several thousand dollars and converting that relatively small balance to a Roth, the tax hit may be minor, even non-existent (as you will soon see). If you have a large traditional IRA and convert that account to a Roth, the increase in your taxable income may send you into a higher tax bracket in the year of the conversion.²

From a pure tax standpoint, it makes sense to start small when you create a backdoor IRA and begin the process with a new traditional IRA funded entirely with non-deductible contributions. If you go that route, the Roth conversion is tax free, because you have already paid taxes on the money involved.¹

The takeaway in all this? When considering a backdoor IRA, evaluate the taxes you might pay today versus the tax benefits you might realize tomorrow.

The taxes on the conversion amount, incidentally, are calculated pro rata – proportionately in respect to the original, traditional IRA’s percentage of pre-tax contributions and earnings. If you are converting multiple traditional IRA balances into a backdoor Roth – which you can do – you must take these percentages into account.¹

Three footnotes are worth remembering. One, a backdoor Roth IRA must be created before you reach age 70½ (the age of mandatory traditional IRA withdrawals). Two, you cannot make a backdoor IRA move without earned income because you need to earn income to make a non-deductible contribution to a traditional IRA. Three, joint filers can each make non-deductible contributions to a traditional IRA pursuant to a Roth conversion, even if one spouse does not work; in that case, the working spouse can cover the non-deductible traditional IRA contribution for the non-working spouse (who has to be younger than age 70½).¹

A backdoor Roth IRA might be a real plus for your retirement. If it frustrates you that you cannot contribute to a Roth IRA because of your income, explore this possibility with insight from your financial or tax professional.

Marc Aarons, 714-887-8000 or Marc@ocmoneymanagers.com

MMI Disclosures

_Citations.

_{1 – investors.com/etfs-and-funds/retirement/backdoor-roth-ira-tax-free-retirement-income-legal-loophole/ [4/19/18]}

_{2 – investopedia.com/retirement/too-rich-roth-do/ [1/29/18]}

_{3 – irs.gov/retirement-plans/retirement-plans-faqs-regarding-required-minimum-distributions [11/16/17]}
   

_{This material was prepared by MarketingPro, Inc., and does not necessarily represent the views of the presenting party, nor their affiliates. This information has been derived from sources believed to be accurate. Please note – investing involves risk, and past performance is no guarantee of future results. The publisher is not engaged in rendering legal, accounting or other professional services. If assistance is needed, the reader is advised to engage the services of a competent professional. This information should not be construed as investment, tax or legal advice and may not be relied on for the purpose of avoiding any Federal tax penalty. This is neither a solicitation nor recommendation to purchase or sell any investment or insurance product or service, and should not be relied upon as such. All indices are unmanaged and are not illustrative of any particular investment.}

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The Pros & Cons of Roth IRA Conversions
What are the potential benefits? What are the drawbacks?
Provided by Marc Aarons @ Money Managers, Inc.

If you own a traditional IRA, perhaps you have thought about converting it to a Roth IRA. Going Roth makes sense for some traditional IRA owners, but not all.

Why go Roth? There is an assumption behind every Roth IRA conversion – a belief that income tax rates will be higher in future years than they are today. If you think that will happen, then you may be compelled to go Roth. After all, once you are age 59½ and have had your Roth IRA open for at least five years (five calendar years, that is), withdrawals of the earnings from your Roth IRA are exempt from federal income taxes. You can withdraw your Roth IRA contributions tax free and penalty free at any time.^1,2

Additionally, you never have to make mandatory withdrawals from a Roth IRA, and if your income permits, you can make contributions to a Roth IRA as long as you live.²

For 2017, the contribution limits are $135,000 for single filers and $199,000 for joint filers, with phase-out ranges respectively starting at $120,000 and $189,000. (These numbers represent modified adjusted gross income.)²

While you may make too much to contribute to a Roth IRA, you have the option of converting a traditional IRA to a Roth. Imagine never having to draw down your IRA each year. Imagine having a reservoir of tax-free income for retirement (provided you follow Internal Revenue Service rules). Imagine the possibility of those assets passing to your heirs without being taxed. Sounds great, right? It certainly does – but the question is: can you handle the taxes that would result from a Roth conversion?^1,3

Why not go Roth? Two reasons: the tax hit could be substantial, and time may not be on your side.

A Roth IRA conversion is a taxable event. The I.R.S. regards it as a payout from a traditional IRA prior to that money entering a Roth IRA, and the payout represents taxable income. That taxable income stemming from the conversion could send you into a higher income tax bracket in the year when the conversion occurs.²

If you are nearing retirement age, going Roth may not be worth it. If you convert a large traditional IRA to a Roth when you are in your fifties or sixties, it could take a decade (or longer) for the IRA to recapture the dollars lost to taxes on the conversion. Model scenarios considering “what ifs” should be mapped out.

In many respects, the earlier in life you convert a regular IRA to a Roth, the better. Your income should rise as you get older; you will likely finish your career in a higher tax bracket than you were in when you were first employed. Those conditions relate to a key argument for going Roth: it is better to pay taxes on IRA contributions today than on IRA withdrawals tomorrow.

On the other hand, since many retirees have lower income levels than their end salaries, they may retire to a lower tax rate. That is a key argument against Roth conversion.

If you aren’t sure which argument to believe, it may be reassuring to know that you can go Roth without converting your whole IRA.

You could do a multi-year conversion. Is your traditional IRA sizable? You could spread the Roth conversion over two or more years. This could potentially help you avoid higher income taxes on some of the income from the conversion.²

Roth IRA conversions can no longer be recharacterized. Prior to 2018, you could file a form with your Roth IRA custodian or trustee to undo a Roth IRA conversion. The recent federal tax reforms took away that option. (Roth IRA conversions made during 2017 may still be recharacterized as late as October 15, 2018.)²

You could also choose to “have it both ways.” As no one can fully predict the future of American taxation, some people contribute to both Roth and traditional IRAs – figuring that they can be at least “half right” regardless of whether taxes increase or decrease.

If you do go Roth, your heirs might receive a tax-free inheritance. Lastly, Roth IRAs can prove to be very useful estate planning tools. If I.R.S. rules are followed, Roth IRA heirs may end up with a tax-free inheritance, paid out either annually or as a lump sum. In contrast, distributions of inherited assets from a traditional IRA are routinely taxed.³

Marc Aarons, 714-887-8000 or marc@ocmoneymanagers.com

MMI Disclosures

^Citations.

^{1 – cnbc.com/2017/07/05/three-retirement-savings-strategies-to-use-if-you-plan-to-retire-early.html [7/5/17] 2 – marketwatch.com/story/how-the-new-tax-law-creates-a-perfect-storm-for-roth-ira-conversions-2018-03-26 [3/26/18] 3 – time.com/money/4642690/roth-ira-conversion-heirs-estate-planning/ [1/27/17] This material was prepared by MarketingPro, Inc., and does not necessarily represent the views of the presenting party, nor their affiliates. This information has been derived from sources believed to be accurate. Please note – investing involves risk, and past performance is no guarantee of future results. The publisher is not engaged in rendering legal, accounting or other professional services. If assistance is needed, the reader is advised to engage the services of a competent professional. This information should not be construed as investment, tax or legal advice and may not be relied on for the purpose of avoiding any Federal tax penalty. This is neither a solicitation nor recommendation to purchase or sell any investment or insurance product or service, and should not be relied upon as such. All indices are unmanaged and are not illustrative of any particular investment.}

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