There are so many benefits that come with the Roth IRA conversion. Roth IRA today has become so incredibly popular and there is a reason for that. The contributions to the Roth IRA are usually made with the income that has already been taxed, which means two things; 1) there will be no initial tax benefit to the money, and 2) that money will grow tax-free.
Another reason why the Roth conversions are popular today is the fact that they do not come with the Required Minimum Distributions (RMDs) at the age of 72 just like the traditional IRA. This means that the account holder can let his or her money grow in value until the time when they decide to access it.
In situations where a person wishes to access their money, they will not pay any income taxes on their money since technically, they already paid the taxes even before they contributed the money.
What Is Roth IRA Conversion?
It is a saving strategy! That is the simplest possible answer to this question. It is a retirement saving strategy that is in many ways beneficial for SOME clients. Remember, like with all financial strategies, benefits will come only by looking at a case-by-case basis, thus it is important to first determine if it is a good fit for a particular client.
In a Roth IRA conversion, the account holder will take, some or all of the balance in the traditional retirement account and will convert it to a Roth IRA.
When doing the conversion, the money being converted will only be taxed in the year of conversion, as ordinary income. This is one of the cases of a Roth IRA conversion.
Another possible scenario is where the client is leaving an employer. In this case, a traditional 401 (k) account will be converted or rolled over to a Roth IRA. The Roth conversion rules regarding tax will still apply. However, depending on the rules of both the client’s 401(k) plan and the rules of the IRA custodian, an interim traditional IRA may be required.
Why Do A Roth IRA Conversion Right Now?
Many financial experts agree that over time, taxes will rise. Thus, by taking your contributions from your traditional IRA, you will be paying less in taxes right now as compared to taking these contributions sometime in the future.
Considering the number of people that have been impacted by the pandemic, and also the number of people who have been laid off from work, there is a huge opportunity to take advantage of the lower-income in 2021 to convert traditional IRAs to Roth IRAs.
Be that as it may, Roth IRA conversions may not be the right move for everyone. So when should you do these conversions?
- When the taxes are low.
- When your income is reduced.
- When you have money that is due in taxes.
- When you do not want to leave your beneficiaries with high tax bills.
Both 2020 and 2021 are experiencing historically low rates which means that now would be a really great time to do the conversions. When you convert right now, you will pay less in taxes., which means, you do not have to pay higher taxes in retirement.
Uncle Sam is coming for our IRAs. The recent tax law changes snuck in some BIG CHANGES to how money must be distributed from the IRAs in the future. Yes, you the owner of the IRA can postpone distributions until the age of 72, but what most people don’t know is that beneficiaries are going to be pummeled with taxes.
The “Stretch IRA” strategy is gone. The new 10-year rule effectively destroys the life expectancy payout. Now the entire IRA balance must be distributed by December 31 of the year that contains the 10th anniversary of the date of death of the original IRA owner.
That may not seem like a big deal, but it is. Prior to the SECURE Act, beneficiaries could take distributions from an inherited IRA over their lifespan-taking a little each year, which is, for most people, didn’t negatively affect their current income tax bill. But, now if you wait too long to take distributions, you are basically building a tax bomb. Uncle Sam is going to get his money within 10 years rather than over the beneficiary’s lifetime.
That is great for the government but it is horrible for the people, especially when you consider where the income taxes are likely to be in the future. Double Whammy! Assuming that we’ll be in a higher income tax bracket in the future. These accelerated IRA distributions could wipe out a third or more of the IRA Balance which makes total sense why to do the Roth IRA Conversion right now.
Here is an example; John dies in 2022 with $200,000 left in his IRA which he leaves to his only son, bob. Lucky Bob right! Let’s say Bib is 45 in 20222. Assuming the IRA continues to grow (Bob has an amazing investment advisor working with him!) and leaves the account to compound for a full 10 years without taking any distributions. For the sake of easy math, let’s assume that the account does extremely well and doubles in the next 10 years. Bob realizes WOW- I have to pull the entire inherited IRA today (if he doesn’t withdraw the entire account balance by the end of the 10th year- Uncle Sam has a penalty!)
So in 2032 (10 years after the death of his dad), Bob is sitting on an inherited IRA worth $200,000 that must be liquidated before Dec. 31st- all in one lump sum. What will that do to his tax bracket? Can you see how the government is going to pay for all the “free money” they’re handing out? It isn’t going to be pretty for future IRA beneficiaries.