What is a Roth IRA Conversion and Why Consider it Now?
A Roth Conversion is a taxable distribution from an IRA. Proceeds are then contributed to a tax deferred Roth IRA. If taxes are paid using funds outside of the IRA, the full amount of the Roth IRA will grow tax deferred. A Roth IRA is attractive because there is no tax due on distributions at retirement.
Please see the following video about the Roth IRA conversion opportunity.
Disclosure: This video was created when the CARES Act was signed into law in March 2020. Please be aware there have been several updates to the CARES act since then.
Opportunity Created due to a Convergence of Circumstances
The Corona virus Aid, Relief, and Economic Security Act, commonly called the CARES Act, was approved by Congress and signed into law on March 27, 2020 in response to the loss of jobs and economic devastation resulting from the need to shut down the economy due to the fast spreading novel corona virus.
Among the CARES Act legislation, the following provide temporary retirement account access:
- Waiver of the 10% Early Withdrawal penalty on IRA distributions up to $100,000 for 2020 (relating to younger folks)
- Waiver of Required Minimum Distributions (RMD’s) for 2020 (relating to older folks) Note: For those who have already take a RMD in 2020, you may return it by August 31, 2020.
Additional Converging Factors
The Tax Cuts and Jobs Act (TCJA) was major tax reform approved by Congress and signed into law on December 22, 2017. The legislation temporarily reduced federal income tax backets from 2018 through 2025. In 2026, the changes will expire and 2017 rates will return, without further legislation.
Depending on the outcome of the 2020 elections, tax rates may increase sooner than 2026. See the Trump-Biden Tax Proposal Comparison.
Considering the burgeoning federal deficit and the CARES Act $2 Trillion stimulus (resuscitation) funds in response to Covid-19, it is likely that Congress may allow the temporarily reduced tax rates to lapse. This will effectively be a tax hike to pre-2017 levels.
The Setting Every Community Up for Retirement Enhancement Act of 2019 (SECURE Act) was approved by Congress and signed into law on December 20, 2019 includes a new “10 year Rule”. It is a provision that limits the time an IRA must be distributed to non-spousal beneficiaries. The favorable stretch IRA, allowing for a longer time to distribute funds to non-spousal beneficiaries, is no longer available.
Despite the broader stock market indices recovering much of their value from the March 2020 lows, your portfolio may not have fully recovered. It is preferable to convert your IRA to Roth IRA while your portfolio value remains low.
Roth IRA Conversion Calculator
To use the Roth IRA Conversion calculator, you will need to gather the following:
Your IRA Investments – Value of all your non-Roth IRA’s and how much you would like to convert from a Traditional IRA to a Roth IRA.
Current and Future Tax Rates – Your tax filing status, estimated taxable income, estimated federal income tax rate at time of first withdrawal and whether or not to include state states.
Time Horizon and Risk – Number of years until you expect to take your first withdrawal from the converted funds and your risk profile/expected rate of return on your IRA investments.
Please see the video for my explanation about how to use the Roth IRA conversion calculator.
Be Careful – Taxes will be Due
A Roth IRA Conversion is a taxable event. If you decide to proceed with a Roth IRA Conversion, please run it by your CPA or Tax Professional to verify the potential tax benefit. Once you convert your IRA to Roth IRA, it cannot be reversed.
hillkat@hkfinancial.com
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