IRA monies – Pay the tax now or later?

Have you wondered if converting IRA monies to a Roth IRA makes sense for you?  We’ll help you understand five situations where a Roth IRA conversion might be in your best interest.  And we’ll discuss how future tax rates factor into this decision.

First, the five situations…

If you fit any of the following criteria, this may warrant additional planning conversation with one of our advisors on whether this strategy fits your situation:

  1. You’re subject to income phase outs and are no longer able to contribute to a Roth IRA.
        • Contribution limit for a Roth IRA of $6,000 in 2022, plus $1,000 catch up if you’re 50 or above.
        • Roth IRA phase outs based on Modified Adjusted Gross Income (MAGI) in 2022:
          • Starts at $204,000 MAGI for Married Filing Jointly or Qualified Widower.
          • Starts at $129,000 Single or Head of Household, Married Filing Separately.
    1. You’ve done a good job saving for retirement and find yourself with an imbalance between pre-tax versus after-tax dollars. For example:
        • Most of your Retirement savings are in pre-tax (Traditional) retirement accounts, with less in after-tax investment or savings accounts.
        • Your projected demands on your retirement accounts are below the overall growth expectation for those accounts.
        • Your Income tax rate is projected to increase once you start Required Minimum Distributions (RMD’s)
    2. You have after-tax money in savings to pay for the taxes owed from a Roth IRA conversion. This is important because:
        • If you are younger than 59.5 the IRS imposes a 10% penalty on withdrawals prior to that age. The Roth Conversion itself is not a withdrawal, but the payment of taxes from IRA funds is.
        • The full conversion amount stays invested and growing for the future.
    3. You’re approaching retirement in the next 10 years, and you find yourself in a lower income year. If so, you can do a conversion to fill up to an appropriate tax bracket (top of the 24% for example).  Some situations when this may apply:
        • You’re self-employed and you find yourself with less income.
        • Took unpaid leave or stepped away from work for a year? You may be in the ideal situation to take advantage of finding your tax equilibrium going forward.
    4. You like the idea of funding a legacy gift to your children or beneficiaries. Roth IRAs can be a great option to do this because:
        • Even though they are still subject to the 10-year payout rule under Secure Act Inherited IRA rules, they retain the tax-free nature passing assets without tax burden to your beneficiaries.
        • They are ideal for money you don’t anticipate using in your Retirement accounts, but still accessible to you if plans change.

And now, future tax rates…

If you are in the camp that tax rates are headed higher, a Roth IRA conversion could be a useful strategy for you.  This is a “pay now vs. later” approach that could help you keep control over your tax liability in retirement, or once you start taking required minimum distributions from your pre-tax (traditional) retirement accounts.   

For some context, average marginal income tax rates have held pretty steady since 1988, but according to the Congressional Budget Office, marginal tax rates are expected to trend higher through 2028.

In closing…

Two last considerations when deciding on a Roth conversion are the amount of time the Roth IRA funds will stay invested, and how aggressive these monies will be invested.  The higher the return and longer the Roth IRA is invested, the more this strategy makes up for paying taxes now versus in the future.   

We’d like to help you solve for these variables and talk through whether this strategy fits your situation. While P&A doesn’t provide tax advice, we can collaborate with you and your accountant on whether this strategy helps fulfill your long-term goals.  Give us a call or send us an email with your questions.

 

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Pittenger & Anderson, Inc. does not provide tax, legal, or accounting advice. This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, tax, legal, or accounting advice. You should consult your own tax, legal, and accounting advisors before engaging in any transaction.  Additionally, the information presented here is not intended to be a recommendation to buy or sell any specific security.  To learn more about our firm and investment approach, check out our Form ADV.

To view this article and others like it online, visit the P&A blog at https://pittand.com/blog/.

Click here to download the PDF version of this article. 

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Since 1995, Pittenger & Anderson has guided individuals and families going through money-in-motion events. We are a fee-only Registered Investment Advisor and a full-time fiduciary providing investment management, financial planning, and complimentary services to 700+ clients in over 30 U.S. states.

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