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The economy is doing well by many measures. Every small rise in GDP (gross domestic product, our total output of goods and services) brings us to a new record. The unemployment rate sits at a 50 year low.
Yet the federal budget deficit is in excess of one trillion dollars, a record. A massive deficit when the economy is this good is unprecedented. When the next recession strikes, we may need to spend an additional trillion dollars a year on top of the current annual shortfall.
The moral of the story: some believe that tax rates will be higher in the future.
If you have 401(k) or traditional IRA balances, you might think about converting some fraction of those balances into a Roth IRA. The downside: you will have to pay income tax on the amount you convert. The upside: once those taxes are paid, those funds will be immune from higher tax brackets later.
The future growth will also be free of tax, if withdrawal rules are followed. And Roth balances are exempt from Required Minimum Distributions, the requirement that you take money out every year after age 70.
Each of you has a different situation, different circumstances. We cannot know the future. But it makes sense to talk about and think about what may happen in your situation. A Roth conversion might make sense.
If you are in a low bracket this year relative to what you believe you might be paying later, we should talk. You can use up the lower brackets with Roth conversions instead of letting them go unused.
Clients, if you would like to talk about this or anything else, please email us or call.
Content in this material is for general information only and not intended to provide specific advice or recommendations for any individual.
This information is not intended to be a substitute for specific individualized tax advice. We suggest that you discuss your specific tax issues with a qualified tax advisor.
The economic forecasts set forth in this material may not develop as predicted and there can be no guarantee that strategies promoted will be successful.
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.
The Roth IRA offers tax deferral on any earnings in the account. Withdrawals from the account may be tax free, as long as they are considered qualified. Limitations and restrictions may apply. Withdrawals prior to age 59 ½ or prior to the account being opened for 5 years, whichever is later, may result in a 10% IRS penalty tax. Future tax laws can change at any time and may impact the benefits of Roth IRAs. Their tax treatment may change.
The Roth IRA concept was passed into law in 1997. It may be more pertinent than ever before. You see, once dollars are placed in a Roth, all the growth is free of tax when withdrawn, as long as the account is five years old and you are older than 59 ½.
Traditional retirement savings provide a tax advantage up front: contributions are not subject to income tax. Later on, withdrawals are taxed. The conventional wisdom was that tax brackets could be lower in the retirement years, so the tax later might not be too bad.
The way things look today, we may never see lower brackets than we have today. There are reasons to think that income taxes will be rising:
• The federal income tax changes passed in 2017 were temporary, with the old higher rates coming back after five years.
• Sooner or later the government may need more revenue to deal with record budget deficits and record national debt.
So the old conventional wisdom about lower tax brackets later may no longer apply. The Roth route may be the way to go.
What does this mean?
• Anybody with earned income may contribute to a Roth IRA, even past age 70, subject to a maximum income limit.
• Some employer plans (401k, 403b etc.) have Roth-type options that many employees could change to.
• Young adults with gifted UTMA accounts or other investments could use those funds to start Roth IRA’s.
• Parents or grandparents looking to give the next generation a boost could fund Roth IRA’s for any who have earned income.
• Anybody with IRA balances may convert any amount they choose to Roth, regardless of income. The converted amounts are subject to income tax, but ever after, the Roth benefits are in place.
The tax implications of a Roth conversion can be complicated. You should seek advice from a professional tax consultant. Your own situation and views should rule any decisions you make. Since we cannot know the future, there is no way to know which path is best. Like so many things in life, we will do the best with what we know.
Clients, if you would like to talk about this or anything else, please write or call.