There may be a silver lining in today’s market conditions.
Low tax rates and depressed asset values can make this a great time to convert to a tax-saving Roth IRA.
You’ll want to look before you leap, though. It’s important to consider several factors—including your overall financial plan—before you jump on the Roth bandwagon.
What is a Roth Conversion?
In a Roth conversion, account owners shift some or all money from a tax-deferred IRA into a Roth IRA.
Funded with after-tax dollars, Roth IRAs feature tax-free withdrawals, which can be advantageous down the line.
One note of caution: Roth conversions cannot be undone.
Why Convert to a Roth IRA?
There are several compelling reasons to convert to a Roth IRA—particularly at this time in history when the coronavirus has turned the financial world on end.
Depressed Market Values
Converting a traditional IRA to a Roth during a market downturn such as we’re experiencing today can provide significant tax advantages.
A Roth conversion is a taxable event—tax is based on the value of the traditional IRA at the time of the conversion.
By converting when values are lower, account owners can enjoy lower tax costs today and tax-free recovery growth.
Lower Tax Rates
The Tax Cuts and Jobs Act of 2017 produced some of the lowest tax rates in recent history.
As a result, you may stand to pay a lower tax rate now than in the future, as income tax rates are scheduled to increase in 2026.
Additionally, Roth conversions may lower future tax liabilities.
While assets in a traditional IRA benefit from tax-deferred growth, future required minimum distributions (RMDs) are taxed at ordinary income rates.
By contrast, Roth IRAs grow tax free, distributions are tax free, and there are no RMDs unless the account has been inherited.
Reduced Taxes for Heirs
The SECURE Act, which took effect earlier this year, tightened rules considerably for inherited IRAs.
With some exceptions, beneficiaries must now deplete these accounts within 10 years of inheritance. This means they’ll ultimately pay taxes at higher rates over a shorter time.
Making a series of Roth IRA conversions over several years could be more advantageous than burdening heirs with higher taxes on accelerated distributions.
What Are the Considerations?
Increasing taxable income can have an impact on other parts of your financial life.
For example, if you’re unclear what your income will be for the year, a Roth conversion may result in a larger tax bill. Ensuring you have appropriate funds to pay this bill will be important.
Here’s our Lead Advisor, Rob Greenman, to break down some additional considerations:
How Vista Can Help
Whether this move is right for you depends on your specific situation—there is no one size fits all when it comes to Roth conversions.
Vista is happy to help you determine how this strategy might fit into your financial plan.