Does a Roth Conversion make sense? In many cases, yes. (Especially in 2021)

Does a Roth Conversion make sense? In many cases, yes. (Especially in 2021)

| October 22, 2021
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As we near the end of 2021, many clients should be considering Roth conversions. This year, in addition to the normal discussion about whether or not to convert, clients should also take into account proposed legislation potentially limiting strategies like backdoor and mega backdoor Roth IRAs.

 Most clients should consider Roth conversions every year as part of their year-end tax planning. Will your income be lower than normal? Do you have room left within your current tax bracket you could fill up with income generated by a conversion? Questions like these can help you determine if a Roth conversion makes sense. Here are three other considerations: 

  1. Taking Advantage of Low Tax Rates

    Remember, in most cases IRAs are not tax-free. Unless the IRA is donated to charity, someone will likely pay taxes on the IRA distributions, whether that is the original account holder or the IRA’s beneficiaries. IRAs are subject to Required Minimum Distributions once the account holder reaches age 72. Clients who have done a good job saving may end up having to take more out of their IRA than they need, potentially resulting in higher taxes than might be necessary. Because IRA distributions are generally treated as income subject to ordinary income taxes, those distributions could impact the taxability of Social Security benefits. Thanks to the Tax Cut and Jobs Act of 2018, tax rates for 2021 remain historically low. This can make a Roth IRA conversion more prudent this year than might be the case in future years. And if you plan to make more than $400,000 in future years, 2021 might be your best chance to do a conversion while you’re in a relatively low tax bracket.

  2. Offsetting Taxes with Charitable Contributions

    The Coronavirus Aid Relief and Economic Security (CARES) Act, which remains in place for 2021, provides higher limits for charitable deductions. Under the CARES Act, taxpayers can deduct charitable contributions up to 100 percent of their adjusted gross income. For those who are charitably inclined, this may be the year to increase charitable contributions. These higher charitable deductions can be used to offset some or all of the taxes that would be due on a Roth conversion.

  3. Paying Taxes for the Next Generation

    The SECURE ACT mandated that inherited IRAs for non-spousal beneficiaries must be fully depleted within 10-years of inheriting the IRA. Even though inherited Roth IRAs are also subject to this 10-year rule, if the original account holder has satisfied the five-year rule prior to death, then beneficiaries will not be required to pay taxes on distributions from the inherited Roth IRA.

While current year tax liability is an important consideration, it is not the only consideration, nor is it the most important consideration. Most clients want to minimize taxes over their lifetime. Others simply don’t want to burden the next generation with additional taxes regardless of what tax bracket that generation may or may not be in. Whatever the reason, most clients should be considering Roth conversions, especially as we approach the end of 2021.

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