Roth IRA con­ver­sion may be the an­swer

- Robert Pow­ell Colum­nist Robert Pow­ell, CFP, is the edi­tor of TheStreet’s Re­tire­ment Daily and con­trib­utes reg­u­larly to USA TO­DAY. Got ques­tions about money? Email Bob at rpow­ell@allth­ingsre­tire­ Tax Credit · Taxes · Income Tax · Money Tips · Personal Finance · Retirement · Social Security · Business · Lifehacks · Employment · Society · United States of America · Medicare · U.S. Internal Revenue Service · Ira

To some the Roth in­di­vid­ual re­tire­ment ac­count, which now rep­re­sents $1 tril­lion in as­sets in the U.S. and is the fastest-grow­ing seg­ment of the U.S re­tire­ment mar­kets, is the per­fect re­tire­ment ac­count.

Con­sider: Con­tri­bu­tions (up to $6,000 or $7,000 if you’re 50 or older) are made with af­ter-tax dol­lars; your money grows tax-free; and with­drawals may be made tax-free af­ter a re­quired hold­ing pe­riod.

What’s more, un­like a tra­di­tional IRA, there are no re­quired min­i­mum distri­bu­tions (RMDs) for as long as you live. Plus, the distri­bu­tions won’t in­crease fed­eral in­come tax you might pay on your So­cial Se­cu­rity ben­e­fits. And the Roth IRA is an in­come-tax free in­her­i­tance for your ben­e­fi­cia­ries.

There also is no age limit to fund­ing a Roth IRA. If you have earned in­come, you can fund a Roth IRA.

And un­like with a tra­di­tional IRA, you can still fund a Roth IRA even if you have an em­ployer-spon­sored re­tire­ment plan.

To be fair, your con­tri­bu­tions may be lim­ited by how much you earn. But there’s a way around that for some. It’s called a Roth IRA con­ver­sion.

What to know about a Roth IRA con­ver­sion

The Roth IRA con­ver­sion works this way: You take a dis­tri­bu­tion from your tra­di­tional IRA or 401(k) and con­trib­ute that money into a Roth IRA. There are no in­come lim­its for this tac­tic, and the rea­sons for do­ing a Roth IRA con­ver­sion

are many.

Many ad­vis­ers be­lieve tax rates will rise over time. By tak­ing a dis­tri­bu­tion from your tra­di­tional IRA you’ll be pay­ing less in taxes now than if you took a dis­tri­bu­tion from your tra­di­tional IRA in the fu­ture.

“Roth con­ver­sions can make sense only if you be­lieve that taxes in gen­eral, or your tax rate in par­tic­u­lar, will be higher in the fu­ture than they are to­day,” says Mark Byelich, a cer­ti­fied fi­nan­cial plan­ner with At­tle­boro Wealth Man­age­ment.

And that’s likely to hap­pen ac­cord­ing to his re­search, which sug­gests that the av­er­age mid­dle-class Amer­i­can will be in the 40%-45% ef­fec­tive tax rate within the next 10 to 15 years.

What’s more, Cerulli As­so­ci­ates re­cently noted that leg­isla­tive changes could fur­ther mo­ti­vate tax­pay­ers to save on a Roth ba­sis or con­vert tra­di­tional bal­ances to Roth. For in­stance, the Set

ting Ev­ery Com­mu­nity Up for Re­tire­ment En­hance­ment (SE­CURE) Act of 2019, which elim­i­nated the so-called stretch IRA, now re­quires non-spousal ben­e­fi­cia­ries to draw down the en­tire IRA bal­ance within 10 years of the ac­count owner’s death.

“This could mo­ti­vate IRA ac­count hold­ers (es­pe­cially those with hig­h­earn­ing ben­e­fi­cia­ries) to fa­vor Roth ac­counts, al­low­ing for tax-free distri­bu­tions in the fu­ture,” Cerulli As­so­ci­ated noted in its re­port.

Others agree. “The SE­CURE Act added the com­plex­ity of re­mov­ing RMDs and cre­ated a D-Day event for ben­e­fi­cia­ries,” said Joseph Clark, a man­ag­ing part­ner with Fi­nan­cial En­hance­ment Group. “The Roth con­ver­sion elim­i­nates the D-Day im­pact of all the in­come be­ing tax­able in one year for uni­formed heirs.”

Distri­bu­tions have con­se­quences. To be sure, the dis­tri­bu­tion from your tra­di­tional IRA could have short-term fi­nan­cial con­se­quences. In a re­cent we­bi­nar, Matt Curf­man and Dan Vre­de­veld, both cer­ti­fied fi­nan­cial plan­ners with Rich­mond Broth­ers, noted that distri­bu­tions could push you into a higher tax bracket and lead you to pay more tax on cap­i­tal gains, or lead to ad­di­tional tax on your So­cial Se­cu­rity in­come, or you might pay a higher than stan­dard Medi­care Part B and Part D pre­mium be­cause of some­thing called the in­come re­lated monthly ad­just­ment amount, or you might lose some or all of the pre­mium tax credit that you re­ceive to cover the pre­mi­ums for your health in­sur­ance pur­chased through the Health In­sur­ance Mar­ket­place.

Avoid th­ese mis­takes. Ad­vis­ers also cau­tion against mak­ing Roth IRA con­ver­sion – or what some call an IRA-to-Roth-IRA rollover – mis­takes. For in­stance, make sure the funds are trans­ferred trustee to trustee. Note too that SIM­PLE IRAs can­not be con­verted un­til af­ter two years, and in­her­ited IRAs can­not be con­verted into a Roth IRA. What’s more, RMDs from a tra­di­tional IRA can­not be con­verted into a Roth IRA.

A back-door Roth IRA. If you earn too much to con­trib­ute to a Roth IRA, con­sider a “back-door Roth IRA.”

With this tac­tic, you would con­trib­ute to a nond­e­ductible tra­di­tional IRA, which doesn’t have an in­come limit for con­tri­bu­tions, and then con­vert those funds into a Roth – in­come tax-free. One caveat: This strat­egy works best if you don’t have an ex­ist­ing tra­di­tional IRA. If you do have an ex­ist­ing tra­di­tional IRA, you’ll be sub­ject to the IRS’ pro rata rule and be re­quired to pay taxes on a por­tion of the con­ver­sion.

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GETTY IMAGES A Roth IRA con­ver­sion is straight­for­ward but do your home­work.
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