ROTH Conversions

Are you concerned with retirement and the taxation of your retirement funds? Now may be the time to utilize the declined stock market as a tax planning opportunity.

As an overview, you can either have a traditional IRA or a Roth IRA. Traditional IRA contributions generally receive a tax deduction when made, and then distributions at retirement are fully taxable at ordinary income tax rates. On the contrary, for Roth contributions you do not receive a tax deduction in the year of a contribution, and distributions at retirement are not taxable. For the contribution’s element, the difference between the two is simply the timing of the tax benefit; however, for the cumulative earnings portion, Roth accounts provide you a greater tax benefit since the appreciation of your account is also tax-free.   One last difference between the two IRA options is that Roth IRAs do not have a mandatory distribution age; whereas traditional IRAs currently must begin distributions when the taxpayer reaches age 72.

Often individuals may not be eligible to make a Roth contribution due to their income exceeding a certain threshold. For 2022, a married filing joint taxpayer is ineligible to make a Roth contribution once their income exceeds $214,000 ($144,000 for single taxpayers). When this occurs, individuals may utilize backdoor Roth conversions or Roth conversions as tools to convert traditional IRAs to Roth IRAs. When an individual converts a traditional IRA to a Roth IRA, the fair market value of what is converted is included in taxable income. Therefore, you pay tax on the amount converted, but that converted amount will now grow tax free and receive the benefits of a Roth account.

When the stock market is in a declined state, you are maximizing the tax benefit of what you are converting because the fair market value is lower.  For example, you may be able to convert what was $100,000 of value in prior year, at a current value of $65,000 and thus pay less tax on the conversion. If utilizing the Roth conversion strategy, it is recommended to have cash outside of the IRA funds available to cover the taxes generated as a result of the conversion, and you need to be mindful of the five-year rule. Regardless of age, the individual must wait five years from the date of their first contribution before withdrawing from the converted Roth to avoid incurring a 10% penalty.

As always, before utilizing this tool please consult with your financial adviser and tax consultant.