design

Everyone Is Talking about Roth IRA Conversions – Here’s Why

As investors emerge from a tumultuous market in the first quarter of 2022, the current volatility may pose an opportunity for IRA account holders. Those who hold IRAs (and 401(k) accounts that allow for Roth conversion) may be considering whether it’s advantageous to convert a portion of their pre-tax IRAs to a Roth.

Here I provide two reasons why current market conditions are favorable for Roth conversion planning:

1. Current Market Conditions

 Converting a pre-tax traditional IRA to a Roth IRA will result in taxable income based upon the fair market value of the assets in the IRA at the time of conversion. However, once the account is converted to a Roth IRA, current law allows any future growth to be withdrawn income tax-free, so long as the account owner is at least 59½ years old and has had at least one Roth IRA opened for five years on the date of withdrawal. Thus, it may be advantageous to utilize a Roth conversion at a time when markets are down and the tax liability will be based off a lower valuation.

  • SEE MORE Are You Being Too Frugal in Retirement?

For example, if an individual in the 24% federal tax bracket converts a $100,000 traditional IRA to a Roth IRA, her taxable income for the year will increase by $100,000. Assuming she remains in the 24% bracket with this additional $100,000 of income, she would owe roughly $24,000 in federal taxes at the time of conversion. If a market correction reduces her account balance by 20% and she converts the account at an $80,000 value, her federal income tax from the conversion would fall to $19,200, yielding a $4,800 tax savings. Once the funds are held inside a Roth IRA, any future market rebound and appreciation will be free of tax.

2. Possibility of Tax Increase

Absent congressional action, reduced tax brackets initiated by the Tax Cuts and Jobs Act (TCJA) in 2018 will sunset on Jan. 1, 2026. The chart below illustrates the reduced tax rates brought on by the TCJA.

Courtesy of Michael Aloi

Unless Congress changes the 2022 tax brackets through tax reform, converting a traditional IRA to a Roth in 2022 could result in a lower marginal federal tax rate than would be applied in 2026 or later. Given that traditional IRAs are subject to required minimum distributions, it may be advantageous to consider converting a portion of the IRA to a Roth while tax rates are reduced.

Other Considerations

The decision to convert all or a portion of your pre-tax IRA accounts depends upon an individual’s own facts and circumstances. Taxpayers are advised to speak with their tax and financial advisers prior to undertaking a Roth conversion. Some of the additional considerations include:

  1. State and local taxes: Roth conversions will increase taxable income in the year of conversion, which will also increase state and local taxes. Taxpayers should consider their retirement goals before executing a Roth conversion. If an individual currently lives in a high-tax state but plans to retire in a state without income taxes, there is a disincentive to convert to a Roth now. Furthermore, state and local taxes paid are currently deductible only up to $10,000 for federal tax purposes. Absent congressional action, state and local taxes paid will be fully deductible in 2026 (subject to the Alternative Minimum Tax).
  2. Current vs. Retirement Tax Brackets: For individuals still in their earning years, consideration should be given to their projected income tax bracket in retirement. For example, a taxpayer presently in the top tax bracket may be in a lower tax bracket during retirement, even with the scheduled increase in tax brackets. That could mean waiting to make a conversion may make sense.
  3. Legislative Risk: While Roth IRAs are presently income tax-free upon distribution and are not subject to required minimum distributions, there have been some legislative efforts to limit Roth IRAs. For example, there is a risk that Congress may change the laws in the future, so that taxpayers in higher tax brackets must pay tax on Roth earnings or required minimum distributions must be taken from Roth IRAs.
  4. Cash-Flow Planning to Pay Tax Liability: Ideally, the taxes triggered by a Roth conversion should be paid out of other after-tax accounts, allowing the entire IRA being converted to continue to grow income tax-free. Individuals looking to convert their traditional IRA to a Roth IRA should understand the tax implications of a conversion and how much additional tax liability will be generated.
  5. Avoid Required Minimum Distributions: Under current law, holders of traditional IRAs are required to take annual distributions from their IRAs beginning the year after they turn 72. Unlike traditional IRAs, a Roth IRA currently does not have required minimum distributions. Converting an IRA to a Roth would allow the account holder to continue growing their retirement account without any need to take required minimum distributions.

Final Thoughts

There are many reasons to consider a Roth IRA conversion. However, one should consult with a qualified financial adviser equipped to understand the individual’s entire financial picture to determine whether this strategy may be appropriate.

For more information on Roth conversions please email me at [email protected]. And for a deeper dive, join our April 7 Roth Conversion Webinar with Senior Tax Specialist James Rabasca (register here).

Investment advisory and financial planning services are offered through Summit Financial LLC, an SEC Registered Investment Adviser, 4 Campus Drive, Parsippany, NJ 07054. Tel. 973-285-3600 Fax. 973-285-3666. This material is for your information and guidance and is not intended as legal or tax advice. Clients should make all decisions regarding the tax and legal implications of their investments and plans after consulting with their independent tax or legal advisers. Individual investor portfolios must be constructed based on the individual’s financial resources, investment goals, risk tolerance, investment time horizon, tax situation and other relevant factors. Past performance is not a guarantee of future results. The views and opinions expressed in this article are solely those of the author and should not be attributed to Summit Financial LLC. Links to third-party websites are provided for your convenience and informational purposes only. Summit is not responsible for the information contained on third-party websites. The Summit financial planning design team admitted attorneys and/or CPAs, who act exclusively in a non-representative capacity with respect to Summit’s clients. Neither they nor Summit provide tax or legal advice to clients.  Any tax statements contained herein were not intended or written to be used, and cannot be used, for the purpose of avoiding U.S. federal, state or local taxes.
  • SEE MORE 6 Investment Tips That Can Reduce Worry in Retirement

Apply for a Credit Card and Get Approved: Step-By-Step Guide

A credit card can be a useful tool for managing your money. But before tapping into the benefits, the first thing to know is how to get a credit card. There are some requirements, and some tips that can help when it comes to getting approved. Here’s the lowdown on the key things to know […]

The post Apply for a Credit Card and Get Approved: Step-By-Step Guide appeared first on SoFi.

When to Change Tax Withholdings — and How to Do It

Wondering when you need to change your tax withholdings — and how to actually do so? We break it all down quicker than you can say “W-4.”

This was originally published on The Penny Hoarder, which helps millions of readers worldwide earn and save money by sharing unique job opportunities, personal stories, freebies and more. The Inc. 5000 ranked The Penny Hoarder as the fastest-growing private media company in the U.S. in 2017.

What Is the Average Credit Card Limit and How Can You Increase It?

When you get a credit card, it comes with a credit limit. This is the maximum amount that a cardholder can spend on the card before needing to pay the credit card’s balance. A credit limit is sort of like a loan maximum — the higher the credit limit, the more money the cardholder can […]

The post What Is the Average Credit Card Limit and How Can You Increase It? appeared first on SoFi.

Why the Sandwich Generation Just Got Worse for Women

As we celebrate national Women’s History Month this March, it’s a great moment to take a look at all of the pressures and pulls on women’s time and energy. The pandemic has exacerbated the “typical” issues facing the sandwich generation by creating even more challenges for women, in particular. This should no longer be called the sandwich generation for women, but instead, the club sandwich generation.

The Sandwich Generation

This clever term refers to the generation (consisting of women, in most cases) being caught, or sandwiched, between kids who are struggling financially and need help and elderly parents who are also struggling and need help. These simultaneous burdens on women during the pandemic have heightened their financial and emotional stress.

  • SEE MORE 5 Ways COVID-19 Has Affected Women’s Financial Planning

Women, in greater numbers than men, have had to take off work to care for kids who couldn’t go to school; take off time from work to care for their adult children returning to the nest because they may have lost their jobs or became ill; and also, take time off to care for and take parents to doctors.

Why the Big Deal?

It’s because the real “meat in the sandwich” (women) are worried about not having enough “bread” to support all the generations relying upon them for financial help.  The pressures mount as life shifts. People are living longer, which is great, but that also means that elderly parents may need more help for a longer period of time.  That translates into the sandwich generation often having to give up their work to care for their parents.  The sandwiched women may be raising their own younger kids, and then couple that with their older kids moving back home, and we have a recipe for real financial burden.

  • SEE MORE A Woman’s Guide to Long-Term Care

The big deal is that women are still the caregivers, in most cases.  They are pulled in too many directions. As discussed, the pandemic forced many to leave the workplace to handle all of these circumstances.  Many moms are single and are under even more pressure. 

What Can Be Done?

Take a Deep Breath

The first thing to consider is to try to balance all of your obligations and try not to be stretched so thin that you burn out because so many people depend upon you. Although it may sound impossible, you need to even schedule a daily “time-out” for yourself to take a walk or to meet or Zoom with a friend. Once you do, you’ll be more “present” to help the others in your life.

Have the Talks

Talk to your kids and parents about sharing all the household responsibilities. Older kids may have to pitch in with caring for their grandparents. Maybe older kids could help with cleaning the house and taking Grandma or Grandpa to the doctor.  Younger kids can even help by spending time with their grandparents.  They could play cards or Scrabble or a watch TV with them. Also, grandparents may be healthy enough to be in charge of the younger kids’ homework, or babysitting for them.  This will not only free up some time for you, but may save you some money, as well.

Craft a Family Budget

Design a family budget with the whole family, all of the generations, in mind.  The adult kids may have to take jobs that don’t meet their expectations. Be honest about what you can and can’t afford.  Ask each member what they are willing to sacrifice.  Give them each a goal to reduce their expenditures.  Maybe they each have to figure out how to save, say, $50 a week to contribute back into the family budget.  Let them come up with ways to save.  If your parents shouldn’t be driving, it is a perfect time to get rid of their car and insurance costs. 

Your younger kids can think about cutting down on family discretionary spending on entertainment; everything from designer coffee to streaming services. Set up a family challenge to rotate the making of meals, including the freezing of an extra meal.  This will help you to save time and money. Shop in bulk.  You get the point.

Don’t Touch Your Retirement Savings

It’s tempting to start to liquidate or borrow from your retirement savings, but there are consequences.  Try not to touch that money, because it’s so hard to build that back up again.  Think about the consequences of you just kicking the can down the road for your kids, who could then become the next sandwich generation financially caring for you.

Seek Help

There are lots of professionals to help you to navigate these choppy financial waters and to design a plan forward. Also, many communities are offering support groups; you are not alone. You may learn of new resources and coping skills.  You may have thought somewhere in your mind that this could happen, but you can’t understand it until you are knee-deep in the situation.

We know that you are capable of doing everything — work, family, friends, volunteering, all of it. Let’s face it, as we look at celebrating Women’s History Month, you need to also celebrate yourself. You are the lynchpin of the family.

  • SEE MORE Women Who Bring Home the Bacon Are STILL the Ones Frying It Up in a Pan