Tax reform has delivered the lowest income tax rates in many years. These relatively low rates expire after five years. This brings up a great planning opportunity. The idea is to see if converting retirement assets to Roth IRA’s makes sense.
This is a classic “pay me now or pay me later” calculation. Normally, we want to pay later. But if we might get a discount on our taxes by paying now, we need to think about it.
Just as the best time to start Social Security retirement benefits depends partly on a fact we can’t know, the date of our death, the Roth conversion calculus has to include an assumption about future tax rates.
Some believe that with the spiraling budget deficits and national debt, tax rates must necessarily rise in the future. This makes sense to us, but we really cannot know. So having some assets in Roth format and some in traditional IRA format is a form of “tax diversification.” Split the difference.
Bottom line, your tax consultant might believe you will never foreseeably get below the 22% tax bracket (for example). So if you convert to Roth at a current tax cost of 22% and you or your heirs are ultimately taxed at 22% when funds are withdrawn, you broke even. The same after-tax money is available.
It is handy to note that breaking even produces some advantages. You will have greater ability in the future to choose where your withdrawals come from, and thus manage your future tax exposure year by year. You also could take out a lump sum from the Roth to help a child or buy a boat without aggravating your taxes that year. And you may avoid Required Minimum Distributions on the conversion.
If you convert to Roth at 22% and avoid future higher tax on withdrawals by you or your beneficiaries, you gained in terms of the after-tax result.
Clients, we believe we need to have this conversation with many of you before the end of 2018. It might significantly improve your financial security (or not.) If you have questions about this or any other topic, email us or call or set an appointment.
The opinions voiced in this material are for general information only and are not intended to provide specific tax advice or recommendations for any individual.
Traditional IRA account owners should consider the tax ramifications, age and income restrictions in regards to executing a conversion from a Traditional IRA to a Roth IRA. The converted amount is generally subject to income taxation.
This is a hypothetical example and is not representative of any specific situation. Your results will vary. The hypothetical rates of return used do not reflect the deduction of fees and charges inherent to investing.