USA TODAY US Edition

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@allthingsr­etirement.com.

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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