ROTH IRA

Roth IRAs and the New Tax Laws

As most of you probably know, the new tax law that went into effect for 2018 presents both challenges and opportunities for many. For many of our clients, one of the opportunities this change created concerns Roth IRA conversions.

To refresh your memory, a Roth conversion is different from a Roth contribution. A conversion simply “converts” existing IRA dollars into a Roth IRA and triggers income tax on the conversion amount as it gets added to the rest of your income for the year. Conversions also have no income limitations. Contributions allow you to deposit after-tax money up to a certain amount annually into your Roth account. There are income limitations as to whether you qualify to make those contributions or not.

So why, you may ask, are conversions such great opportunities right now? Before the tax law took effect and lowered the rates for many, we were already at some of the lowest income tax rates in 60 years. It’s my opinion this makes Roth conversions very valuable for many who are in retirement or headed into retirement very soon.

You can convert IRA dollars today at a lower tax rate rather than waiting until the IRA pot is even bigger and paying taxes at a much higher rate later. Would you rather pay taxes on the seed or the harvest? This has already been a viable opportunity for many of our clients for many years, as we believe that, unless some things change in Washington, tax rates will be higher in the future. We’ve also educated clients on the issues we see with over-funded, pre-tax retirement accounts (RMD’s, lack of tax-efficient options in retirement) in the lives of retirees and the need to mitigate that risk before they enter retirement years.

As great an opportunity as this is, there are many things to consider and you will want to talk to your tax and financial advisors about what would be best for your situation.

One of the primary reasons to do even more due diligence on this topic before executing a conversion is that the new tax law eliminated the ability to re-characterize your conversion or, in layman’s terms, reverse your decision. We normally recommend making Roth decisions in the 4th quarter of the year and typically not after December 15th since many custodians can’t handle the request volume and won’t guarantee that it gets processed timely.

With the right analysis and strategy, the new tax law’s higher standard deduction and lower rates creates the potential to “unwind” IRAs into tax-free vehicles. Also, increases in the estate tax exemption mean that you can pass on your Roth to beneficiaries tax-free (at least until 2025 when the law has to be re-approved or else go back to pre-2018 tax levels).

Gifting exclusions also allow for some interesting strategies such as gifting family members funds to pay the tax on their own Roth conversion (to get them started) or to make their own Roth contribution without the worry of gift limitations. This can help younger families get started building their Roths.

There are also provisions that could be helpful in regards to leaving more money to grandchildren, by way of the generation–skipping transfer tax (GST) exemption. Also, those who may be subject to the “kiddie-tax” rules and even IRAs that have trusts as beneficiaries could find some help through the new law and conversions.

Finally, one of the questions people have in doing a conversion is “what if I do this, pay all this tax upfront and then Uncle Sam changes the game on me?”

Unfortunately, no one knows that answer. Historically however, Roth’s have been a terrific revenue generator for the Feds and let’s face it, they like that! This is why they dropped the income limitation on conversions back in 2010.

The best you can do is to plan around what you know today and adjust annually as needed. Stay in the game and stay on top of what’s going on.

Let us know how we can help you find clear direction for your retirement with these strategies, we’d be honored to visit with you. We are more than happy to help you with an analysis on this or to any other issue related to your retirement plan.

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