Business Cents: Is Now the Right Time to Go Roth?
Provided by Garrett German
Will federal income tax rates ever be lower than they are right now? Given the outlook for Social Security and Medicare, it is hard to imagine them falling much further. Higher federal income taxes could very well be on the horizon, as the tax cuts set by the 2017 reforms are scheduled to sunset when 2025 ends.
Not only that, the federal government is now using a different yardstick, the chained Consumer Price Index, to measure cost-of-living adjustments in the federal tax code. As an effect of this, you could gradually find yourself in a higher tax bracket over time even if tax rates remain where they are, and today’s tax breaks could eventually be worth less.
So, this may be an ideal time to convert a traditional IRA to a Roth. A Roth IRA conversion is a taxable event, and so if you have a traditional IRA, you may be thinking twice about it. If the IRA is large, the taxable income linked to the conversion will be sizable, and you could end up in a higher tax bracket in the year the conversion occurs. That literally may be a small price to pay.
What would you rather have – years of tax-free IRA withdrawals, or years of IRA withdrawals that might be taxed more than they would be today? If you decide against going Roth, you leave a door open to that second possibility. If you go Roth, you open the door to the first.
The jump in your taxable income for the year of the conversion may be a headache – but like many headaches, it promises to be short-lived. Consider the many perks that could come from transforming a traditional IRA balance into a Roth IRA balance (and remember that any taxpayer can make a Roth conversion, even a taxpayer whose high income rules out the chance of creating a Roth IRA).
Generally, you can take tax-free withdrawals from a Roth IRA once the Roth IRA has been in existence for five years and you are age 59½ or older. If you end up retiring well before 65 (and that could happen), tax-free and penalty-free Roth IRA income could be very nice.
You can also contribute to a Roth IRA all your life, provided you earn income and your income level is not so high as to bar these inflows. In contrast, a traditional IRA does not permit contributions after age 70½ and requires annual withdrawals once you reach that age.
Lastly, a Roth IRA is convenient in terms of estate planning. Roth IRA assets transfer to your heirs without being taxed.
A Roth IRA conversion need not be “all or nothing.” Some traditional IRA owners elect to convert just part of their traditional IRA to a Roth, while others choose to convert the entire balance over multiple years, the better to manage the taxable income stemming from the conversions.
Remember, however, that you can no longer undo a Roth conversion. The Tax Cuts & Jobs Act did away with so-called Roth “recharacterizations” – that is, turning a Roth IRA back to a traditional one. Now, this do-over is no longer allowed.
Talk to a tax or financial professional as you weigh your decision. This really does look like a prime time for pre-retirees to go Roth, but the move is not for everyone. Occasionally, the resulting tax hit may seem to outweigh the potential long-run advantages. Study the various financial implications before making the move.
Garrett German, CFP is a part owner of 2020 Financial Advisors. He may be reached by calling at 559-592-3200, emailing email@example.com or visiting www.2020fa.com.
Securities offered solely through Ameritas Investment Corp. (AIC). Member FINRA/SIPC. Investment advisory services offered through AIC or 20/20 Capital Management Inc. AIC is not affiliated with 20/20 Financial Advisors or 20/20 Capital Management, Inc. Additional products and services may be available through 20/20 Financial Advisors or 20/20 Capital Management, Inc. that are not offered through AIC. Representatives of AIC do not provide tax or legal advice. Please consult your tax advisor or attorney regarding your situation.
– This column is not a news article but the opinion of the writer and does not reflect the views of The Foothills Sun-Gazette newspaper.