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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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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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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.

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© 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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