Roth Conversions

Roth IRAs are a great tool that allows an investor to create assets that will not be taxable in the future.  Imagine if the bulk of your investable assets were positioned for you and potentially the next generation where no one would have to pay taxes again, powerful stuff.  One of the issues with Roth IRA’s are the income limits that prohibit families above certain income levels from being able to contribute to them.

Those investors that may not be able to contribute to Roth IRA’s due to these limits and even others that want to put more monies in their Roth can look at using a strategy called Roth Conversions.  Essentially this strategy allows you to convert IRA monies that have been put away pre-tax to a Roth IRA by paying the taxes on the conversion amount in the year of conversion.  At current, there are no limitations, due to age or income, that prevent you from doing a conversion.

Why a conversion?

The conversion can assist you with several financial planning benefits.  First, you have now reduced the amount of pre-tax IRA assets which will effectively reduce your RMDs in the future because the base that it is determined from will be lower today and most likely in the future too.  You are also paying taxes on the conversion amount in the year of conversion, rather than in the years you remove the monies later on.  Being that we are currently at historically low tax rates there is a good chance that these rates will rise and leave you to pay the tax today at the lower levels rather than taking it out later at the higher rates.  The conversion also will allow your Roth assets to grow and taxes will not be paid on those future amounts later.  Whether you use the funds or they are passed on to your heirs, who could be in a higher tax bracket than you, no one will have to pay taxes on these funds when they are removed.

This is not an exhaustive list by far and you need to weigh the pros and cons of conversion for yourself.  This may be something that you approach all at once or a strategy that you determine to use over multiple years to spread out the tax burden over a longer period.

Benefits of a Downturn

Using this strategy during a market downturn, like we have seen thus far in 2022 can present you with an even better opportunity. There is a great example of the benefits for investors in an article written by Ryan Yamada, CFP® on Carson’s Advanced Solutions Team written back in 2020 during the pandemic that is relevant today and highlights the benefits.  The downturn allows you to convert a lower amount of funds, since your account may have declined, which would most likely mean a lower amount of taxes owed as a result.  The benefit is as the markets rebound and the account grows back and hopefully, beyond its value before the decline you will not (nor will your heirs) owe any taxes on the account.

Market downturns like we are experiencing are now providing times to take a deep breath and see if there are opportunities to make minor adjustments to your thinking that can benefit you and your family for the long term.  This is a strategy when it makes sense, that can provide immense benefits over the long term, and is invaluable.  Keep in mind that Roth conversions can be complicated and need to be coordinated with your wealth advisor and tax advisor too.  This is not something that should be done without the proper due diligence and we would be happy to connect and begin the process.  You can feel free to schedule a 30 Minute Zoom Meeting for us to discuss if this is something you think may be right for you.

This article represents the opinion of Mitlin Financial Inc. It should not be construed as providing investment, legal and/or tax advice. Investing involves risk, including possible loss of principal. No strategy assures success or protects against loss. To determine what may be appropriate for you, consult your financial advisor.

Converting from a traditional IRA to a Roth IRA is a taxable event.Some IRA’s have contribution limitations and tax consequences for early withdrawals. For complete details, consult your tax advisor or attorney.A Roth IRA offers tax free withdrawals on taxable contributions. To qualify for the tax-free and penaltyfree withdrawal or earnings, a Roth IRA must be in place for at least five tax years, and the distribution must take place after age 59 ½ or due to death, disability, or a first time home purchase (up to a $10,000 lifetime maximum). Depending on state law, Roth IRA distributions may be subject to state taxes. Distributions from traditional IRA’s and employer sponsored retirement plans are taxed as ordinary income and, if taken prior to reaching age 59 ½, may be subject to an additional 10% IRS tax penalty.

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