Is A ROTH Conversion Right For You? – Four Considerations To Help You Decide

The decision to convert part or all your traditional IRA to a Roth IRA depends on several factors, including your current and future tax situation, legacy aspirations, financial circumstances and time horizon. Here are some items to consider.

Tax situation:  While congress could modify or extend current tax laws, right now, many are going to “sunset” in 2025.  Current income tax rates were lowered with the TCJA of 2017, with the highest rate dropping from 39.6% to 37%.  Rates are set to go back up starting in 2025.  The standard deduction nearly doubled with the TCJA and again is set to expire in 2025.  Many people were able to get larger deductions with this rather than itemizing.  You want to navigate the tax waters with what lies down river in mind.  It may be prudent to convert part of your traditional IRA to a ROTH if you anticipate your tax rate will increase in the future or because deductions will decrease. Whatever you take from your IRA is taxed as ordinary income.  You can facilitate a conversion with portions of your IRA up to desired tax thresholds over the next couple of years.  If your earned income is lower and you delay taking Social Security until 70, you can optimize your conversions even more.

Legacy aspirations: If you are fortunate and plan to pass financial assets on to others, a ROTH conversion now may be a consideration. The SECURE Act of 2021 eliminated the stretch IRA and now, non-qualified heirs need to liquidate traditional or ROTH within ten years following the owner’s death.  If a non-qualified heir inherits a traditional IRA after you had started taking RMD, they need to continue to take the RMD AND liquidate the remainder within 10 years. This may push beneficiaries into unanticipated higher tax brackets.  Traditional IRA money is the least tax efficient way to leave money to real persons. The ROTH IRA will still need to be liquidated within 10 years, but will be done tax free with no RMD requirements.   If you have philanthropic objectives, you can name a charitable organization as beneficiary of your traditional IRA and utilize the Qualified Charitable Distribution (QCD) for your RMD every year and skip the ROTH conversion idea.

Cash flow needs: Converting traditional to ROTH entails paying ordinary income on what you convert.  You want to have cash available to pay the taxes due instead of needing to liquidate additional IRA money, hence increasing your tax bill.  It is important to look at your lifestyle and liquidity needs and what your current as well as longer term life transitions warrant. You can’t touch the money for five years.  The five-year rule on distributions from your ROTH starts on Jan 1 of the year in which you make the conversion. Each conversion starts a new five-year clock.  ROTHs are best positioned as income stream tools when tax rates are higher.

Time Horizon:  The longer the ROTH has time to bake in a tax-deferred oven, with growth focused asset allocation ingredients, the more likely you will end up ahead of the game. Delayed gratification is the name of this game.  You need at least five years with the IRS ruling from conversion to distribution..   For example, converting in a market that has pulled back will have you paying less in taxes.  Currently, you must start taking the required minimum distributions out of your traditional IRA at age 73.  However, the ROTH has no RMD.   If time is on your side, the market is moving toward a growth cycle and you can harness that growth within your ROTH for your future or that of your heirs, you may want to consider this strategy.

ROTH conversions are not for everyone and there are many moving parts to consider.  Your distribution season has very different terrain than the accumulation season and it is important that your financial professionals are considering all the variables to optimize your future income streams, life transitions and legacy goals.

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