Five windows of opportunity for Roth conversions

VaselineOctober 5, 2024

0 3 minutes read

Five windows of opportunity for Roth conversions

Converting a traditional IRA to a Roth IRA might be a prudent move for some people, as it can provide significant tax advantages in retirement. But when are the best times to do a Roth conversion?

First, let’s look at some pros and cons of a Roth conversion. Unlike a traditional IRA, which is funded with pre-tax money, qualified withdrawals from a Roth IRA are tax-free. Another difference from traditional IRAs is that Roth IRAs are not subject to required minimum distributions or RMDs (unless inherited), thereby reducing taxable income in retirement.

The problem is that you have to pay income tax on the converted amount in the year you convert. That’s why when considering a Roth conversion, it’s important to weigh the amount of upfront taxes, the increase in adjusted gross income, and the associated tax implications.

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Given that money in a Roth IRA grows tax-free and is withdrawn tax-free, the upfront tax hit may be worth it for some investors. For others, the added conversion fee can be prohibitive. Being aware of the following five windows of opportunity to make a Roth conversion can help maximize your tax benefits.

1. When the market is down

A significant decline in the stock market, which reduces the value of your portfolio, presents one of the best opportunities to make a Roth conversion. That’s because you’ll pay the conversion fee with less money. If, for example, your traditional IRA was $100,000 and it dropped to $70,000 when the market went down, you would convert the smaller amount.

The reason you convert money into a Roth IRA is so you can withdraw it tax-free in retirement. Converting when the market is down allows you to convert a larger portion of your account for the same cost. And when the market rebounds, you’ll get tax-free growth on your converted money.

2. When you anticipate a change in tax brackets

Income tax brackets may change after some provisions of the Tax Cuts and Jobs Act expire at the end of 2025. For example, the 22% bracket is set to rise to 25%, and the 24% bracket will rise to 28% . With historically low tax rates right now, converting a traditional IRA or 401(k) to a Roth can make sense.

3. When you are between retirement age and your RMD

For many people, their lowest level of annual income will be after retirement, but before RMDs begin at age 73. If they haven’t started taking Social Security, it can be even lower during that retirement/pre-RMD period. That time frame can provide an ideal window to take advantage of the lower income tax bracket to do a Roth conversion.

Also remember that you don’t have to convert all your pension funds at once. You can spread those conversions over several years, limiting the tax and conversion amounts that allow you to stay in your tax bracket. A common scenario might be a married couple in the 22% tax bracket. They retire at 65, but their RMDs are eight years apart, and now they’re in a lower bracket until they start taking RMDs.

4. When you are in a low income year

Earning less money in a given year than you usually do could put you in a lower tax bracket, a good opportunity to convert pre-tax assets into a Roth. It is often wise to wait until near the end of your low-income year to convert, as you will have a better idea of your total income and marginal tax rate.

5. When you plan ahead for your heirs

A Roth conversion can be a great way to remove the tax burden from your heirs. Converting from a traditional IRA to a Roth IRA allows your savings to grow RMD-free, potentially leaving more for your heirs to withdraw tax-free. However, non-spousal beneficiaries who inherit Roth IRAs must follow IRS distribution rules and take RMDs. In some cases, heirs must withdraw all Roth IRA funds within 10 years of the account owner’s death.

Some say timing is everything, and that can be largely true when considering a Roth conversion. Roth IRAs can be a valuable retirement financial tool, giving you more flexibility and potentially lowering your tax bill.

Dan Dunkin contributed to this article.

The appearances in Kiplinger were obtained through a public relations program. The columnist received assistance from a public relations firm in preparing this article for submission to Kiplinger.com. Kiplinger was not compensated in any way.

This article was written by and reflects the views of our contributing advisor, not the Kiplinger editorial staff. You can check advisor records with help dry or with FINRA.

VaselineOctober 5, 2024

0 3 minutes read

Vaseline

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