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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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Lowering your taxes with year end planning

Lower Your Tax Bill with Year-End Planning

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Tips to Help Lower Your Tax Bill with Year-End Planning

As the end of the year draws near, the last thing anyone wants to think about is taxes. But if you are looking for ways to minimize your tax bill, there’s no better time for tax planning than before year-end. That’s because there are a number of tax-smart strategies you can implement now that may reduce your tax bill come April 15 or in the years ahead.

Consider how the following strategies might help to lower your taxes.

Put Losses to Work

If you have capital gains, IRS rules allow you to offset your gains with capital losses. Short-term gains (on assets held one year or less) are reduced by short-term losses, and long-term gains (on assets held longer than a year) are reduced by long-term losses. If your net long-term capital gain is more than your net short-term capital loss, the net capital gain generally is taxed at a top rate of 20%.1 A net short-term capital gain, on the other hand, is taxed at ordinary rates, which range as high as 37%. To the extent that losses exceed gains, you can deduct up to $3,000 in capital losses against ordinary income on that year’s tax return and carry forward any unused losses for future years.

Given these rules, there are several actions you should consider:

  • Avoid short-term capital gains when possible, as these are taxed at higher ordinary rates. Unless you have short-term capital losses to offset them, consider holding the assets until you’ve met the long-term holding period (generally, more than one year).
  • Take a good look at your portfolio before year-end and estimate your gains and losses. Some investments, such as mutual funds, incur trading gains or losses that must be reported on your tax return and are difficult to predict. But most capital gains and losses will be triggered by the sale of the asset, which you usually control. Are there some winners that have enjoyed a run and are ripe for selling? Are there losers you would be better off liquidating? The important point is to cover as many of the gains with losses as you can, thereby minimizing your capital gains tax.
  • Consider taking capital losses before capital gains, since unused losses may be carried forward for use in future years, while gains must be taken in the year they are realized.

When determining whether or not to sell a given investment, keep in mind that a few down periods don’t mean you should sell simply to realize a loss. Stocks in particular are long-term investments, subject to ups and downs. Likewise, a healthy unrealized gain does not necessarily mean an investment is ripe for selling. Remember that past performance is no indication of future results; it is expectations
for future performance that count. Moreover, taxes should be only one consideration in any decision to sell or hold an investment.

IRAs: Contribute, Distribute, or Convert

One simple way of reducing your taxes is to contribute to a traditional IRA, if you are eligible for tax-deductible contributions. Contribution limits for the 2019 tax year — which may be made until April 15, 2020 — are $6,000 per individual and $7,000 for those aged 50 or older. Note that deductibility phases out above certain income levels, depending upon your filing status and whether you (or your spouse) are covered by an employer-sponsored retirement plan.

An important year-end consideration for older IRA holders is whether or not they have taken required minimum distributions. The IRS requires account holders aged 70½ or older to withdraw specified amounts from their traditional IRA each year. These amounts vary depending on your age. If you have not taken the required distributions in a given year, the IRS will impose a 50% tax on the shortfall. So make sure you take the required minimums for the year.

Another consideration for traditional IRA holders is whether to convert to a Roth IRA. If you expect your tax rate to increase in the future — either because of rising earnings or a change in tax laws — converting to a Roth may make sense, especially if you are still a ways from retirement. You will have to pay taxes on any pretax contributions and earnings in your traditional IRA for the year you convert, but withdrawals from a Roth IRA are tax free and penalty free as long as you’re at least 59½ and at least five years have passed since you first opened a Roth IRA. If you have a nondeductible traditional IRA (i.e., your contributions did not qualify for a tax deduction because your income was not within the parameters established by the IRS), investment earnings will be taxed but the amount of your contributions will not. The conversion will not trigger the 10% additional tax for early withdrawals.

These are just steps you can take today to help lighten your tax burden. Work with a financial professional and tax advisor to see what you can do now to reduce your tax bill.

1A 3.8% tax on net investment income may effectively increase the top rate on long-term capital gains to 23.8% for single taxpayers with a modified adjusted gross income (MAGI) of more than $200,000 and to those who are married and filing jointly with a MAGI of more than $250,000.

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converting to a Roth IRA

Roth IRA Conversion

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Good Window of Opportunity for Roth IRA Conversions

The Roth IRA is a powerful tax-favored retirement option since it can offer a hedge against future tax-rate increases. But beyond tax planning considerations,

Roth IRAs have several important advantages over traditional IRAs:

  1. Unlike a traditional IRA, a Roth IRA distribution is tax-free if you’ve had the account open at least five years, and reached the age of 59½, become disabled or died.
  1. You can make contributions to your Roth IRA after age 70½, depending on whether you fall within the earned income limits.
  2. Roth IRAs are not subject to the traditional IRA rules for required minimum distributions at age 70½.

The Internal Revenue Code allows IRA owners to convert significant sums from traditional IRAs to Roth IRAs. But you have to follow these important rules (among others):

  • The ability to contribute tails off at higher incomes. For 2019, the eligibility to make annual Roth IRA contributions is phased out between modified adjusted gross income (MAGI) levels of $122,000 to $137,000 (unmarried individuals) and $193,000 to $203,000 (married joint filers).1
  • The conversion is treated as a taxable distribution from your traditional IRA. Doing a conversion likely will trigger a bigger federal income tax bill and possibly a larger state income tax bill. However, today’s lower federal income tax rates might be the lowest you’ll see in your lifetime, and the tax benefits of avoiding higher taxes in future years may extend to family members after death.

 

Many tax experts suggest that the best reason to convert some or all of your traditional IRA to a Roth IRA is if you believe your tax rate during retirement will be the same or higher than what you are paying currently. Since you’re no longer allowed to reverse a Roth IRA conversion, it’s important to understand the tax ramifications. Talk to your tax advisor before taking any action.

 

Traditional vs. Roth IRA: High-level Comparison

Here is a simplified comparison of IRA rules and tax benefits. Remember, tax laws are complex and subject to change. Consult a tax advisor about your individual situation before taking action.

 

Traditional IRA Roth IRA
Age limits for contributing You must be under 70½ to contribute. You can contribute to a Roth IRA at any age.
Income limits for contributions Your contributions can’t exceed the amount of income you earned in that year or other IRS-imposed limits. Your contributions can’t exceed the amount of income you earned in that year or other IRS-imposed limits, and can be reduced or eliminated based on your modified adjusted gross income.
2019 tax-year contribution limits If you are under age 50, you can contribute up to $6,000. If you are older than age 50, you can contribute $7,000. (Limits can be lower based on your income.) If you are under age 50, you can contribute up to $6,000. If you are older than age 50, you can contribute $7,000. (Limits can be lower based on your income.)
Claiming deductions on tax return You may be able to claim all or some of your contributions. You cannot deduct your Roth IRA contribution.

 

 

 

 

 

 

1       Source: Bill Bischoff, “How the new tax law created a ‘perfect storm’ for Roth IRA conversions in 2019,” MarketWatch.com, Jan. 16, 2019. https://www.marketwatch.com/story/how-the-new-tax-law-creates-a-perfect-storm-for-roth-ira-conversions-2018-03-26

 

This material was created for educational and informational purposes only and is not intended as ERISA, tax, legal or investment advice. LPL Financial and its advisors are providing educational services only and are not able to provide participants with investment advice specific to their particular needs. If you are seeking investment advice specific to your needs, such advice services must be obtained on your own, separate from this educational material.

 

Kmotion, Inc., 412 Beavercreek Road, Suite 611, Oregon City, OR 97045; www.kmotion.com

 

© 2019 Kmotion, Inc. This newsletter is a publication of Kmotion, Inc., whose role is solely that of publisher. The articles and opinions in this publication are for general information only and are not intended to provide tax or legal advice or recommendations for any particular situation or type of retirement plan. Nothing in this publication should be construed as legal or tax guidance; nor as the sole authority on any regulation, law or ruling as it applies to a specific plan or situation. Plan sponsors should consult the plan’s legal counsel or tax advisor for advice regarding plan-specific issues.

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financial plan

Getting Ready for 2019

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Getting Your Financial Plan Ready for 2019

Last month I wrote about how the Tax Cuts and Jobs Act could affect your year-end planning. Now I’d like to look at year-end planning from a broader perspective. This list should help you get your financial plan ready for the new year:

 

  • It All Starts With Saving…

    Whether you use Mint, a spending tool from your financial advisor, or a year-end report from your bank or credit card issuer, it’s important to track your spending habits. Having a handle on how you spent your money in 2018 will give you an idea of how you can save more in 2019. Sticking to a budget isn’t easy, so start by analyzing reoccurring expenses to find opportunities to save more. It could be cutting the cord (I switched to DirectTV Now this year!), switching to a family cell phone plan or reaching out to your insurance agent to review your policies.

 

  • Instead of Resolutions, Have a Plan…

    This is a good time to look at where you were last year at this time and see if you stuck with your financial plan. If anything has changed in 2018 that affects your long-term goals, this is the time to address them in your plan.

 

  • Make Sure You Have a Liquidity Plan…

    The rule of thumb is to make sure you keep three to six months of expenses in cash to act as an emergency fund. This may be too broad of an approach as everyone’s situation is different. If you take a lot of risk in your career you may want to hold more cash. A larger cash reserve could also apply to retirees that rely on their investments for most of their income.

 

  • Last Chance To Max Out Retirement Plan Contributions…

    The maximum 401(k) employee elective salary deferral for 2018 is $18,500. If you are age 50 or older, you can put in an additional $6,000 as a catch-up contribution. If you are a participant in a SIMPLE IRA plan, the maximum salary deferral is $12,500 and a $3,000 catch-up contribution can be made. The deadline for these contributions is December 31st. If you can put away more for 2018, contact your human resources department to see if more can be taken out of your last paycheck.

 

  • Make sure you take required minimum distributions (RMDs) from your retirement accounts…

    According to the IRS, you must take your first required minimum distribution (RMD) for the year in which you turn age 70½ by April 1st of the following year. After that first year, the distributions must be made by December 31st. Remember, required minimum distributions also apply to inherited IRAs. You must start taking distributions by December 31st in the year following the death of the original owner.

 

  • Is a Roth Conversion Right For You…

    Any money that you convert to a Roth IRA is generally subject to income taxation in the year that you do it. But over the long term, the money will continue to grow tax-free. It also won’t be subject to required minimum distributions (RMD) in retirement. Traditional IRA account owners should consider the tax ramifications, age and income restrictions about executing a conversion from a Traditional IRA to a Roth IRA. Roth conversions must be done by December 31st. If you made any non-deductible contributions to a retirement plan or IRA in 2018, you may be able to convert those to a Roth without any additional tax consequences.

 

  • Review Your Investments and Harvest Tax Losses… 

    2018 has been a volatile year with many asset classes down year to date. You may be able to harvest some losses in your non-retirement investment accounts by offsetting them with realized gains. You can also realize up to $3,000 as a capital loss against your taxable income.

 

  • Making the deadline for a charitable gift… 

    Most charitable gifts must be postmarked or received by December 31st to qualify for a deduction. If you are retired and taking distributions from a retirement account, part of your RMD can be met by making a Qualified Charitable Distribution (QCD). A QCD doesn’t give you a charitable deduction, but it counts against satisfying your required minimum distribution for the year. Therefore, it is excluded from your taxable income. Like your RMD, the deadline for this distribution is December 31st.

 

  • Deducting 529 contributions… 

    Prior to investing in a 529 plan, investors should consider whether the investor’s or designated beneficiary’s home state offers any state tax or other state benefits such as financial aid, scholarship funds, and protection from creditors that are only available for investments in such state’s qualified tuition program. Withdrawals used for qualified expenses are federally tax free. Tax treatment at the state level may vary. Please consult with your tax advisor before investing. If you are in a home state’s plan that offers an income tax deduction on contributions, make sure you get your contribution in by December 31st.

 

  • Is Your Estate Plan Up to Date?… 

    Has anything changed in 2018 that would be a reason to make modifications to your will, health care proxy, or power of attorney? This is also a good time to make sure you have the desired beneficiary(s) on all of your retirement accounts and insurance policies.

 

  • Making the Most of Spending Accounts…

    For 2018, if you are in a high-deductible health-insurance plan, you can fund a health savings account (HSA). Individuals can put away as much as $3,450 before taxes, while families, can put away $6,900. Those age 55 and older can contribute an additional $1,000. You have until April 15th to fund an HSA. If you funded a flexible spending account (FSA) through your employer in 2018, you may have to spend down your balance by the end of the year. Unlike an HSA, FSAs typically don’t allow you to carry over much of a balance into the following year.

 

  • Should You Bunch Medical Expenses by Year End?… 

    For 2018, the adjusted gross income (AGI) floor was lowered to 7.5% and will return to 10% in 2019. Any medical expenses above 7.5% of your AGI can be itemized for deductions. To claim the deduction, you must have itemized deductions that exceed your standard deduction (which is now $24,000 for a married couple). You may consider covering some medical expenses before the end of the year that you were going to hold off on, if it will raise your itemized deductions above your standard deduction. Also, 2019 will be a more difficult year to claim the deduction since the AGI floor returns to 10%.

 

As always is the case, these suggestions are only intended to be used as general information and are not intended to be tax advice. You should always consult a tax professional before making tax planning decisions and work with a trusted financial advisor to help you make the most of 2019.

 

All the best in the New Year.

 

Securities offered through LPL Financial, Member of FINRA/SIPC and investment advice offered through Stratos Wealth Partners Ltd., a Registered Investment Advisor. Stratos Wealth Partners, Ltd. and Lob Planning Group are separate entities from 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. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly.

 

Stratos Wealth Partners, Lob Planning Group and LPL Financial do not provide legal and/or tax advice or services. Please consult your legal and/or tax advisor regarding your specific situation.

 

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Year End Tax Planning: TCJA Edition

Year End Tax Planning: TCJA Edition

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Year End Tax Planning: TCJA Edition

With the passage of the Tax Cuts and Jobs Act (TCJA) last December, year-end tax planning could impact even more individuals. A lot has already been written about how it has limited two key itemized deductions: mortgage interest and state and local taxes (SALT). There are also many potential benefits. The TCJA expands the standard deduction and availability of the child tax credit, made reforms to itemized deductions and the alternative minimum tax, and lowers marginal tax rates. Given these changes, here are some things to consider going into the end of the year:

 

  • Is Tax Deferral Still the Way to Go?- Some individual taxpayers will see their effective tax rate go down in 2018. If you are one of those people, you may want to rethink making tax-deferred contributions to your retirement savings. If you are already in a low tax bracket, you may see more of a long-term benefit by contributing after tax money. In addition to a Roth IRA, some employer retirement plans allow for Roth contributions. Withdrawals from the account may be tax free, as long as they are considered qualified. There are some limitations and restrictions. Withdrawals prior to age 59 ½ or prior to the account being opened for 5 years, whichever is later, may result in a 10% IRS penalty tax. It should also be noted that future tax laws can change at any time and may impact the tax benefits of Roth IRAs.

 

  • Should You Convert Tax-Deferred to Roth?- In addition to making new retirement contributions with after tax money, you may benefit from converting money you have in a tax-deferred retirement account to a Roth IRA. Keep in mind, that any money that you convert to a Roth IRA is generally subject to income taxation in the year that you do it. But over the long term, the money will continue to grow tax-free and won’t be subject to required minimum distributions (RMD) in retirement. Roth conversions must be done by December 31st. Traditional IRA account owners should consider the tax ramifications, age and income restrictions in regard to executing a conversion from a Traditional IRA to a Roth IRA. 

 

  • Should You Take Out More Than Your RMD?- For some retirees with a low income or high medical deductions (threshold decreased from 10% of AGI to 7.5% for 2018), it may actually make sense to take more out of retirement accounts than the required minimum distribution. Even if you don’t need the money to cover expenses, the amount taken above the RMD can be converted to a Roth.

 

  • Bunching Up Your Deductions- With the combination of the standard deduction being doubled and big-ticket deductions, like mortgage interest and SALT, being limited, it is more difficult to meet the threshold for itemizing deductions. With careful planning, you may be able to bunch up deductions like charitable contributions, medical expenses, and unreimbursed employee expenses in one calendar year to get you over the threshold. For example, if you normally make $5,000 in charitable contributions in a calendar year, consider contributing $10,000 to a charity or donor advised fund, and nothing the following year. The donor advised fund will allow you to take the deduction in the year the contribution is made, but offers discretion to give money out over time to the charities of your choosing. While donor advised funds have many advantages, some disadvantages to be aware of include but are not limited to possible account minimums, strict limits on grant allocations, management fees and the potential that future tax laws may change at any time that may impact the tax treatment and benefits of donor advised funds

 

  • Consider a QCD- If you are already age 70 ½, and making charitable contributions, you may consider a Qualified Charitable Distribution (QCD). A QCD doesn’t give you a charitable deduction but it counts against satisfying your required minimum distribution for the year. Therefore, it is excluded from your taxable income. Like your RMD, the deadline for this distribution is December 31st.

 

Keep in mind that these suggestions are only intended to be used as general information and are not intended to be tax advice. You should always consult a tax professional before making tax planning decisions and work with a trusted financial advisor to see how the recent tax laws can affect your investment plan.

 

 

Securities offered through LPL Financial, Member of FINRA/SIPC and investment advice offered through Stratos Wealth Partners Ltd., a Registered Investment Advisor. Stratos Wealth Partners, Ltd. and Lob Planning Group are separate entities from 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. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly.

Stratos Wealth Partners, Lob Planning Group and LPL Financial do not provide legal and/or tax advice or services. Please consult your legal and/or tax advisor regarding your specific situation.

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