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Converting a Traditional IRA to a Roth IRA

Converting a Traditional IRA to a Roth IRA

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Thinking of Converting Your Traditional IRA to a Roth? Now May Be the Time

Anyone who is thinking of converting a traditional IRA to a Roth IRA may want to consider do it this year. Why? Because today’s unique conditions create an opportunity to minimize the tax bite from converting. In fact, many have already taken advantage of this opportunity, with one provider reporting a 67% increase during the first four months of 2020 compared to a year earlier.1

But before you begin to decide whether or not to convert, make sure you are familiar with what’s involved with a Roth conversion.

What’s a Roth Conversion?

When you convert your traditional IRA to a Roth IRA, any deductible contributions you had made, along with any investment earnings, are taxed as ordinary income for the year of the conversion. That means the taxable value of the conversion could push you into higher federal and state tax brackets.

You will be responsible for full payment of all taxes in the year the conversion is made. If you use assets from the traditional IRA to pay those taxes, the tax amounts could be treated as premature withdrawals, so you could be subject to additional taxes and penalties.

Depending upon your personal financial situation, a Roth IRA conversion could potentially provide a tax-adjusted benefit over time, provided you meet the eligibility requirements.

Why Now?

The coronavirus pandemic has created unique conditions that may make a Roth conversion more attractive than usual.

Your taxable income may be lower

If, like millions of Americans, you have been furloughed or laid off, or your sales commissions are down, you will likely report lower taxable income for 2020. This may put you in a lower tax bracket so that monies converted to a Roth would be taxed at a lower rate than would otherwise apply (unless the amount converted pushes you into a higher bracket). For instance, converting a $15,000 IRA when your marginal federal tax rate is 12% saves $1,500 of tax compared to converting at a 22% marginal rate — and that does not include state tax, which might also drop.2

Your business may incur a loss

The pandemic is causing many businesses to close or incur a loss. If you expect to report a business loss on your personal return, you may be able to convert to a Roth at a reduced tax cost. With the Roth conversion creating additional income, you could use the loss generated by the business to offset some or all of that income.

Your IRA balance may be down

To minimize taxes, it’s better to convert assets when they’re low in value. Although U.S. stocks have recovered most of the ground lost in February and March, it’s possible your IRA balance may still be well off its peak, depending on how it is invested.

RMDs are suspended for 2020

As part of the CARES Act, required minimum distributions (RMDs) for traditional IRAs and qualified retirement plans were suspended for this year. Not taking distributions from a traditional IRA might keep or put you in a lower tax bracket by reducing your taxable income, making it even more desirable to convert to a Roth.

Current tax rates are low and could go up

The 2017 Tax Cuts and Jobs Act (TCJA) reduced federal tax rates, cutting the top marginal rate to 37%. That’s relatively low compared with recent history. Given the staggering price tag of the pandemic bailout (so far) and the ballooning budget deficit, it’s reasonable to assume that at some point, tax rates may increase. When this might happen is anyone’s guess, but converting while rates are relatively low is something to consider.

To Convert or Not?

Whether you would be better off leaving your funds in a traditional account or moving all or some of them to a Roth IRA will depend upon your personal circumstances. Generally speaking, Roth IRA conversions are best suited for investors who have significant time until retirement, are high wage earners, think they may be in a higher tax bracket at retirement, or are looking for an estate planning tool to help pass wealth to their heirs.

Whatever your circumstances, keep in mind that IRS rules governing IRAs and conversions are complex. So be sure to consult with a financial or tax professional before deciding.

Source/Disclaimer:

1Money, Roth IRA Conversions Are Surging. Here’s Why This Retirement Savings Strategy Is So Popular Right Now, June 4, 2020.

2Example is for illustration only. Your results will differ.

Traditional IRA account owners have considerations to make before performing a Roth IRA conversion. These primarily include income tax consequences on the converted amount in the year of conversion, withdrawal limitations from a Roth IRA, and income limitations for future contributions to a Roth IRA. In addition, if you are required to take a required minimum distribution (RMD) in the year your convert, you must do so before converting to a Roth IRA.

 This material was prepared by LPL Financial. This material is for general information only and is not intended to provide specific advice or recommendations for any individual. There is no assurance that they views or strategies discussed are suitable for all investors or will yield positive outcomes. Investing involves risks including possible loss of principal. Any economic forecasts set forth may not develop as predicted and are subject to change. All performance referenced is historical and is no guarantee of future results.

 

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The CARES Act and your Savings Plan

The CARES Act and Your Retirement Savings

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Think Twice Before Tapping into Your Retirement Savings

New legislation — the CARES Act — permits qualified individuals to take early distributions from their retirement assets, such as their 401(k) or individual retirement account (IRA) — penalty free. The rules – which sunset after 2020 – are designed to help the many cash-strapped Americans who have suffered financially as a result of the coronavirus epidemic. But tapping into your retirement savings has its costs, and there may be better ways to shore up your short-term cash flow.

The CARES Act

The Act permits qualified individuals to take distributions of up to $100,000 from their IRA or workplace retirement savings plan (if allowed by the plan) without incurring the 10% additional tax on early distributions that would otherwise generally apply to distributions made prior to age 59½. Amounts withdrawn may be repaid within three years, if desired. Note, however, that ordinary income taxes apply to all pretax funds withdrawn, although taxpayers may elect to report the income over three tax years instead of one.

These coronavirus-related distributions may only be made to a “qualified individual” on or after January 1, 2020, and before December 31, 2020. A qualified individual includes anyone who has been diagnosed with the SARS-CoV-2 virus or with coronavirus disease 2019 (COVID-19) by a test approved by the Centers for Disease Control and Prevention, or whose spouse or dependent has been diagnosed. It also includes individuals who experience adverse financial consequences as a result of: being quarantined, furloughed, laid off, or having work hours reduced due to SARS-CoV-2 or COVID-19; being unable to work on account of a lack of childcare due to the virus or disease; closing or reducing hours of a business owned or operated by the individual due to the virus or disease; or other factors as determined by the Treasury Secretary.

The Act also relaxes rules on borrowing from a retirement plan account. If authorized by the plan, qualified individuals may borrow as much as $100,000 or 100% of their vested account balance. These limits are effective from March 27, 2020 to September 22, 2020.

Additionally, qualified individuals with an outstanding loan (on or after March 27, 2020) may delay loan repayments due during the period from March 27, 2020 to December 31, 2020 for up to one year.

Consider the Costs

Withdrawing or borrowing money from your retirement account may seem like an easy way to shore up your short-term cash flow, but there are long-term costs to consider. Most notably, if you withdraw funds and don’t repay them, you’ll be reducing your retirement nest egg, perhaps significantly. And making up for withdrawn balances means contributing more — potentially much more — down the road. That’s because time is a critical ally when saving for retirement. The more time your contributions and earnings have to grow, the better the chance you will be able to reach your retirement savings goals.

If you don’t withdraw the funds altogether, but just borrow them from your plan, you must generally pay back the loan within five years, or earlier if you lose your job or leave your employer voluntarily before the loan is paid back. Otherwise, it will be considered a taxable distribution, requiring you to pay income tax on the amount of the loan. What’s more, current law protects funds held in a qualified plan from creditors in the event of a bankruptcy. So if you are experiencing extreme financial difficulty, keeping funds in your qualified plan may be one way to limit the damage. Even if you’re allowed to defer some loan payments because of the CARES Act, you’ll want to weigh the potential downsides before borrowing.

There May be Better Alternatives

As any financial professional will attest, borrowing from your future to fund today’s temporarily negative cash flow is generally not a good strategy. Instead, consider other sources of funds such as:

  • Short-term loans
  • Tapping into a home equity line of credit
  • Borrowing from friends or relatives

You also may want to consider ways to reduce current costs until your cash flow improves.

  • Reduce credit card payments by consolidating balances on a low-rate card
  • Contact current lenders to arrange for a temporary payment freeze
  • Cut back on discretionary expenses and make a budget

Also keep in mind that the provisions of the CARES Act are temporary. So if the economic fallout from the coronavirus epidemic has left you strapped for cash, try to maintain a long-term focus and stick to your plan.

                                                                                                                                                                            

 

This material was prepared by LPL Financial.

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual security. To determine which investment(s) may be appropriate for you, consult your financial professional prior to investing.

This information is not intended to be a substitute for specific individualized tax or legal advice. We suggest that you discuss your specific situation with a qualified tax or legal advisor.

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Getting prepared to retire

Retiring? Take Control of Your Assets

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Retiring? Take Control of Your Assets

After years of saving and investing, you can finally see the big day — retirement. But before kicking back, you still need to address a few matters. Decisions made now could make the difference between your money outlasting you or vice versa.

Calculating Your Retirement Needs

First, figure out how much income you may need. When retirement was years away, this exercise may have involved a lot of estimates. Now, you can be more accurate. Consider the following factors:

  • Your home base — Do you intend to remain in your current home? If so, when will your mortgage be paid? Will you sell your current home for one of lesser value, or “trade up”?
  • The length of your retirement — The average 65-year-old man can expect to live about 17 more years; the average 65-year-old woman, 20 more years, according to the National Center for Health Statistics. Have you accounted for a retirement of 20 or more years?
  • Earned income — The Bureau of Labor Statistics estimates that by 2022, 23% of people aged 65 or older will still be employed, almost twice the proportion that prevailed in 2002.1 If you continue to work, how much might you earn?
  • Your retirement lifestyle — Your lifestyle will help determine how much preretirement income you’ll need to support yourself. A typical guideline is 60% to 80%, but if you want to take luxury cruises or start a business, you may well need 100% or more.
  • Health care costs and insurance — Many retirees underestimate health care costs. Most Americans are not eligible for Medicare until age 65, but Medicare doesn’t cover everything. You can purchase Medigap supplemental health insurance to cover some of the extras, but even Medigap insurance does not pay for long-term custodial care, eyeglasses, hearing aids, dental care, private-duty nursing, or unlimited prescription drugs. For more on Medicare and health insurance, visit Medicare’s consumer website.
  • Inflation — Although the inflation rate can be relatively tame, it can also surge. It’s a good idea to tack on an additional 4% each year to help compensate for inflation.

Running the Numbers

The next step is to identify all of your potential income sources, including Social Security, pensions, and personal investments. Don’t overlook cash-value life insurance policies, income from trusts, real estate, and the equity in your home.

Also review your asset allocation — how you divide your portfolio among stocks, bonds, and cash. Are you tempted to convert all of your investments to low-risk securities? Such a move may place your assets at risk of losing purchasing power due to inflation. You may live in retirement for a long time, so try to keep your portfolio working for you — both now and in the future. A financial advisor can help you determine an appropriate asset allocation.

                            Robber Baron: Inflation
Here’s how a 4% inflation rate would erode $400,000 over a 25-year period. Because inflation slowly eats away at the purchasing power of a dollar, it’s important to factor inflation into your annual retirement expenses.
 Retiring? Take Control of Your Assets

 
  This example is hypothetical and for illustrative purposes only.

A New Phase of Financial Planning

Once you’ve assessed your needs and income sources, it’s time to look at cracking that nest egg you’ve built up. First, determine a prudent withdrawal rate. A common approach is to liquidate 5% of your principal each year of retirement; however, your income needs may differ.

Next, you’ll need to decide when to tap into tax-deferred and taxable investments. The advantage of holding on to tax-deferred investments (employer-sponsored retirement plan assets, IRAs, and annuities) is that they compound on a before-tax basis and therefore have greater earning potential than their taxable counterparts.2 However, earnings and deductible contributions in tax-deferred accounts are subject to income tax upon withdrawal — a tax that can be as high as 39.6% at the federal level. In contrast, long-term capital gains from the sale of taxable investments are taxed at a maximum of 20%.3 The key to managing taxes is to determine the best strategy given your income needs and tax bracket.

Also, tax-deferred assets are generally subject to required minimum distributions (RMDs) — based on IRS life expectancy tables — after you reach age 70½. Failure to take the required distribution can result in a penalty equal to 50% of the required amount. Fortunately, guidelines do not apply to Roth IRAs or annuities.2 For more information on RMDs, see the IRS’s RMD resource page or call the IRS at 1-800-829-1040.

A Lifelong Strategy

A carefully crafted retirement strategy also takes into account your estate plan. A will is the most basic form of an estate plan, as it helps ensure that your assets get disbursed according to your wishes. Also, make sure that your beneficiary designations for retirement accounts and life insurance policies are up-to-date.

If estate taxes are a concern, you may want to consider strategies to help manage income while minimizing your estate tax obligation. For example, with a grantor retained annuity trust (GRAT), you move assets to an irrevocable trust and then receive an annual annuity for a specific number of years. At the end of that period, the remaining value in the GRAT passes to your beneficiary — usually your child — generally free of gift taxes. Another option might be a charitable remainder trust, which allows you and/or a designated beneficiary to receive income during life and a tax deduction at the same time. Ultimately, the assets pass free of estate taxes to a named charity.

It’s easy to become overwhelmed by all the financial decisions that you must make at retirement. The most important part of the process is to consult a qualified financial professional, a tax advisor, and an estate-planning attorney to make sure that you’re prepared for this new — and exciting — stage of your life.

                   How Much Can You Withdraw?
This chart can give you an idea how much you could potentially withdraw from your retirement savings each year. For example, if you begin with $400,000 in assets and expect an average annual return of 5% over a 25-year retirement, you could potentially withdraw $18,000 per year. Withdraw more than that each year and you may outlive your money. Also consider: This chart doesn’t take income taxes into account, which can range from 10% to 35%, depending on your tax bracket.
 Retiring? Take Control of Your Assets
Assumes 5% average annual return, and that withdrawal rate is adjusted for annual 4% inflation rate after the first year. This example is hypothetical and for illustrative purposes only. Investment returns cannot be guaranteed.

 

1Source: Labor Force Projections to 2022, Monthly Labor Review, U.S. Bureau of Labor Statistics.

2Withdrawals from tax-deferred accounts prior to age 59½ are taxable and may be subject to a 10% additional tax. Neither fixed nor variable annuities are insured by the Federal Deposit Insurance Corp., and they are not deposits of — or endorsed or guaranteed by — any bank. Withdrawals from annuities may result in surrender charges.

3A 3.8% tax on unearned income may also apply.

Because of the possibility of human or mechanical error by DST Systems, Inc. or its sources, neither DST Systems, Inc. nor its sources guarantees the accuracy, adequacy, completeness or availability of any information and is not responsible for any errors or omissions or for the results obtained from the use of such information. In no event shall DST Systems, Inc. be liable for any indirect, special or consequential damages in connection with subscriber’s or others’ use of the content.

© 2017 DST Systems, Inc. Reproduction in whole or in part prohibited, except by permission. All rights reserved. Not responsible for any errors or omissions.

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Facts about an IRA

Brush Up On Your IRA Facts

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If you are opening an individual retirement account (IRA) for the first time or need a refresher course on the specifics of IRA ownership, here are some facts for your consideration.

IRAs in America

IRAs continue to play an increasingly prominent role in the retirement saving and investment strategies of Americans. According to the Investment Company Institute (ICI), more than one third of U.S. households owned IRAs in 2017. Traditional IRAs, the most common variety, are held by more than one quarter of U.S. households, followed by Roth IRAs and employer-sponsored IRAs (including SEP-IRAs, SAR-SEP IRAs, and SIMPLE IRAs).1

Contributions and Deductibility

Contribution limits. In general, the most you can contribute to an IRA for 2018 is $5,500 and it rises to $6,000 in 2019. However, if you are age 50 or older, you can make an additional “catch-up” contribution of $1,000, which brings the maximum annual contribution to $6,500.

Eligibility. One potential area of confusion around IRAs concerns an individual’s eligibility to make contributions. In general, tax rules require that you must have compensation to contribute to an IRA. Compensation includes income from wages and salaries and net self-employment income. If you are married and file a joint tax return, only one spouse needs to have the required compensation.

With regard to Roth IRAs, income may affect your ability to contribute. For tax year 2018, individuals with an adjusted gross income (AGI) of $120,000 (goes up to $122,000 in 2019) or less may make a full contribution to a Roth IRA. Married couples filing jointly with an AGI of $189,000 (goes up to $193,000 in 2019) or less may also contribute fully for the year. Contribution limits begin to decline, or “phase out,” for individuals with AGIs between $120,000 and $135,000 ($122,000 and $137,000 in 2019) and for married couples with AGIs between $189,000 and $199,000 ($193,000 and $203,000 in 2019). If your income exceeds these upper thresholds, you may not contribute to a Roth IRA.2

Deductibility. Whether you can deduct your traditional IRA contribution depends on your income level, marital status, and coverage by an employer-sponsored retirement plan. For instance:2

  • If you are single and covered by an employer-sponsored retirement plan, your traditional IRA contribution for 2018 will be fully deductible if your AGI was $63,000 or less ($64,000 or less in 2019). The amount you can deduct begins to decline if your AGI was between $63,000 and $73,000 ($64,000 and $74,000 in 2019). Your IRA contribution is not deductible if your income is equal to or more than $73,000 ($74,000 in 2019).
  • If you are married, filing jointly, and the spouse making the IRA contribution is covered by an employer-sponsored retirement plan, your 2018 IRA contribution will be fully deductible if your combined AGI is $101,000 or less ($103,000 or less in 2019). The amount you can deduct begins to phase out if your combined AGI is between $101,000 and $121,000 ($103,000 and $123,000 in 2019). You may not claim an IRA deduction if your combined income is equal to or more than $121,000 ($123,000 in 2019).
  • If you are married, filing jointly, and your spouse is covered by an employer-sponsored plan (but you are not), you may qualify for a full IRA deduction if your combined AGI is $189,000 or less. The amount you can deduct begins to phase out for combined incomes of between $189,000 and $199,000 ($193,000 and $203,000 in 2019). Your deduction is eliminated if your AGI on a joint return is $199,000 ($203,000 in 2019) or more.
  • If neither you nor your spouse is covered by an employer-sponsored retirement plan, your contribution is generally fully deductible up to the annual contribution limit or 100% of your compensation, whichever is less.

Keep in mind that contributions to a Roth IRA are not tax deductible under any circumstances.

Distributions

You may begin withdrawing money from a traditional IRA without penalty after age 59½. Generally, previously untaxed contributions and earnings are taxable at the then-current regular income tax rate. Nondeductible contributions are generally not taxable because those amounts have already been taxed.

You must begin receiving minimum annual distributions from your traditional IRA no later than April 1 of the year following the year you reach age 70½ and then annually thereafter. If your distributions in any year after you reach 70½ are less than the required minimum, you may be subject to an additional federal tax equal to 50% of the difference.

Unlike traditional IRAs, Roth IRAs do not require the account holder to take distributions during his or her lifetime. This feature can prove very attractive to those individuals who would like to use the Roth IRA as an estate planning tool.

 

This communication is not intended as investment and/or tax advice and should not be treated as such. Each individual’s situation is different. You should contact your financial professional to discuss your personal situation.

1Investment Company Institute, “The Role of IRAs in US Households’ Saving for Retirement,” 2017.

2Internal Revenue Service, Notice 2017-64.

Because of the possibility of human or mechanical error by DST Systems, Inc. or its sources, neither DST Systems, Inc. nor its sources guarantees the accuracy, adequacy, completeness or availability of any information and is not responsible for any errors or omissions or for the results obtained from the use of such information. In no event shall DST Systems, Inc. be liable for any indirect, special or consequential damages in connection with subscriber’s or others’ use of the content.

© 2018 DST Systems, Inc. Reproduction in whole or in part prohibited, except by permission. All rights reserved. Not responsible for any errors or omissions.

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