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2021: Year of the Roth conversion Thumbnail

2021: Year of the Roth conversion

Roth conversions have been around for years but many investors take a pass when they see how much tax they’ll have to pay to do a conversion. This year may change all that. With tax rates likely headed higher soon, the benefit of converting your IRA to a Roth now may pay off in the long run.

Roth IRAs are a Traditional IRA turned inside out: You fund a Roth with after-tax dollars (e.g., take-home pay) so that it can grow tax-deferred now with tax-free distributions at retirement.1 If you have an existing Traditional IRA or 401(k) account, you can turn it into a Roth by doing a conversion. However, to convert these pre-tax accounts, you’ll need to pay income tax on the amount converted.

For example, if you’d like to convert a $100,000 rollover IRA and you have adjusted gross income of $400,000, you’ll have to come up with $37,000 to pay the taxes.2 Since it doesn’t make sense to pay that tax from the IRA, you’ll need to have cash on hand to pay the conversion taxes. Until now, we have suggested investors do conversions over time to spread out the tax hit. However, with higher tax rates looking more likely, it may make sense to do a larger conversion before the end of 2021.3

There are a couple of other reasons to do a Roth conversion, too.

Reducing the size of your Traditional IRA or 401(k) now may help reduce the size of your Required Minimum Distributions once you reach age 72. If you’ve been a good saver during your working years and you have a large IRA, you your RMDs could be big.

For example, if you had a $1 million IRA at the end of last year (the date used to calculate your RMD), your first required distribution at age 72 this year would be $39,062.50—and that’s all taxable income, whether you want it or not. With a Roth, there is no RMD and qualified withdrawals are tax-free.

So, for some investors, converting a portion of the Traditional IRA or 401(k) now may be a way to reduce their total tax, especially if tax rates go up in the future.

Another consideration is the impact on Medicare premiums. A relatively new feature of Medicare is the graduated premium scale. For a married couple with adjusted gross income of $276,001, they will pay $475.20/month plus $70.70/month for Part D, not the $115.48/month base rate for those with adjusted gross incomes of $176,000 or less. That’s $5,165 more per year than the base rate and it does not include the cost of a Medigap or Medicare supplement policy. For big IRA owners, their RMDs may cause them to pay higher Medicare premiums.

If you have questions about Roth conversions and your retirement, give us a call, we’re here to help. You can schedule a quick call with me by clicking HERE.

Lyman H. Jackson Lyman@PlanWithFPS.com


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· The IRA tax bomb and why Roth conversions are more important than ever

· 4 reasons a Roth IRA conversion might not make sense

· Roth conversion considerations

1 A Roth IRA must be open for at least five years before a qualified withdrawal can be made without penalty. 2 The 2021 federal marginal income tax rate for married filing jointly is 32% plus another 5% for MA state income tax. You may also be subject to additional Medicare and Net Investment Income taxes on the amount converted. 3 Future tax rates are hard to predict. In addition, your personal circumstances should be carefully considered including the number of years until retirement, the number of years until you attain age 72 when required minimum distributions must begin, your other financial resources and obligations, etc.

Financial Planning Solutions, LLC (FPS) is a Registered Investment Advisor. FPS provides this blog for informational and educational purposes only. Nothing in this blog should be considered investment, tax, or legal advice. FPS only renders personalized advice to each client after entering into an advisory relationship. Information herein includes opinions and forward-looking statements that may not come to pass. Information is derived from sources believed to be reliable. Information is at a point in time and subject to change without notice. Such information may not be independently verified by FPS. Please see important disclosures link at the bottom of this page.

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