A Roth Conversion is when you convert a Regular IRA into a Roth. The difference is that when you take distributions from a Roth, there’s no tax due on either the principal or the gains.
But you’re taxed at your regular income tax rate on the amount converted from the Regular IRA. Paying the tax now rather than later may or may not save you some money.
Issues to consider include the following…
1 – A Roth Conversion can push you into a higher income tax bracket. If that bracket is higher than the bracket you would expect to be in when you take distributions in the future, then this might not be a great idea depending on how much you expect your IRA to grow.
2 – If you’re close to or already receiving Medicare Benefits, a Roth Conversion may increase your Medicare Part B and D premiums due to the Income-Related Monthly Adjustment Amount (IRMAA) rules.
3 – Roth Conversions are subject to a separate five-year holding period, starting on the first day of the tax year of the conversion, to avoid a 10% penalty on withdrawals if you’re under age 59 ½.
4 – Timing can be important. Converting during a lower-income year can reduce the upfront tax burden. Also, converting while in a market downturn will also allow you to pay less taxes on a smaller amount.
5 – You don’t have to convert your entire traditional IRA balance at once. You can spread conversions over multiple years to manage your tax liability. If you know that you want to convert a total $200K into a Roth, but also know that you only have another $40K left inside a particular income tax bracket, then only convert $40K that year.
6 – Unlike regular IRA contributions, Roth Conversions cannot be recharacterized back to a traditional IRA.
Let me leave you with this…
Like most things that happen in life, on paper this is easy. The reality of doing it the way that you want can be impossible.
We have a new tax landscape that includes things like deductions on Car Loan Interest and Social Security Benefits becoming non-taxable. These and the other new tax laws must be taken into consideration when making this decision.
But the biggest problem on Roth Conversions for Entrepreneurs is the fact that none of us know how much money we’ll make in a given year. The other is the fact that they probably aren’t done writing tax law for this year yet.
As such, these decisions should probably be postponed until December when we know more about what we’re dealing with.
There’s one other thing to think about when making this choice. It’s an impossible variable, but one that should be considered.
I’ve seen three instances where a taxpayer did the conversion, paid the upfront taxes, and then passed away before being able to benefit from it.
None of us have a crystal ball where we know the date of our ultimate demise. If we did, we’d probably just sit at home and play the stock market.
But it does happen. It’s a situation where paying those taxes upfront can negatively affect your lifestyle in the last years of your life.
What can I say? It’s a tough decision. To do or not to do. That is the question.
Think about it. I’m here if you’d like to talk…
We’re all going to get through this. Let’s get through it together.
Accounting Solutions Ltd. stands ready to complete our mission and purpose of protecting you, your family, and your business. Whether you need Payroll Services, or Accounting and Tax Work, you have but to ask. I’m here and I remain,
Sincerely yours,
Chris Amundson
President
Accounting Solutions Ltd.
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