The quickest way to get a relatively large sum into a tax-smart Roth IRA is by converting a traditional IRA into a Roth account, and you have time before year’s end. Relatively low current tax cost for converting plus a chance to avoid higher tax rates in future years on income that will accumulate in your Roth account equals a continuing perfect storm for the Roth conversion strategy, but you have to get it done this year to start reaping the tax-saving benefits.
- A Roth conversion is treated as a taxable distribution from your traditional IRA. Doing a conversion before year-end can trigger a bigger federal and/or state income tax bill for this year.
- Today’s federal income tax rates might be the lowest ever, so if you convert this year you’ll pay today’s relatively low rates on the extra income triggered by the conversion and avoid the potential for higher future rates on all the post-conversion income that will be earned in your new Roth account.
- Qualified Roth withdrawals taken after age 59½ are totally federal income tax free.
- To be clear, the best candidates for the Roth conversion strategy are people who believe that their tax rates during retirement will be the same or higher than their current tax rates.
- Converting a traditional IRA with a relatively big balance could push you into a higher tax bracket. For example, if you’re single and expect this year’s taxable income to be about $150,000, your marginal federal income tax bracket is 28%. Converting a $100,000 traditional IRA into a Roth account this year would cause most of the extra income from converting to be taxed at 33%. The conversion can be spread over three years. In converting it that way, it would be taxed at 28%.
- You have until October 15th of next year to reverse a 2014 conversion. If for any reason values go awry, the re-characterization (reversal), ensures that things are like the 2014 conversion never happened, and you don’t owe any extra tax from the now-reversed conversion.
- People with a higher tax threshold are not eligible to contribute to a Roth IRA, but may be able to make a non-deductible traditional IRA contribution and immediately convert it to a Roth IRA with no tax consequences.
These moves can be tricky. To make sure you understand all the implications and tax consequences, please schedule time to meet with us at MJW EA & Company LLC, and be sure to check out the Social Security and Retirement Planning page on our website (or click here to be taken there directly).