The primary difference between a Roth IRA and a traditional IRA is how distributions are taxed. Contributions to a traditional IRA are often tax deductible in the year they are made and are taxed at ordinary income rates when withdrawn later in life. Contributions to a Roth IRA are taxed up front, which means future withdrawals are tax-free. In addition, all of the earnings and growth in a Roth IRA are tax-free as well.
Both deductible IRA contributions and Roth IRA contributions are subject to income restrictions. In 2020, the limits for making Roth IRA contributions are as follows:1
For 2020, contributions to both types of retirement accounts are capped annually at $6,000 before the age of 50 and at $7,000 after the age of 50. Individuals with both accounts can contribute to both in the same year as long as they do not exceed their given contribution cap.
As you can see in the below chart, the Tax Cuts and Jobs Act (TCJA) lowered tax rates for individuals beginning in 20183:
These rates are set to expire in 2025, but it is possible they could change before then. Additionally, there is speculation that tax increases may help pay for the economic stimulus that is part of the Coronavirus Aid, Relief, and Economic Security Act (CARES Act).
Given that tax rates are at historic lows, and knowing that they may increase within the next five years, now may be an excellent time to consider a Roth conversion because you may pay less upfront taxes upon conversion today than you would have in the past, or in the future, and you can potentially avoid the higher tax rates that are expected in the future.
SECURE Act (2019)
When the Setting Every Community Up for Retirement Enhancement Act (SECURE Act) was signed into law at the end of 2019, it represented the most extensive change to retirement legislation in over a decade. The Act is wide-ranging and far-reaching in its content, with a number of provisions and tax extenders primarily focused on improving retirement confidence and security for individuals in the U.S.
One of the biggest changes in the legislation was how inherited retirement accounts are treated. Before the SECURE Act, beneficiaries of an inherited IRA could use the life expectancy rule to determine when to take their required minimum distributions (RMD), which meant required distributions could be taken over the life expectancy of the beneficiaries thereby spreading out the tax impact of the inheritance over potentially several decades. But after the SECURE Act was passed, most non-spousal beneficiaries are subject to the 10-Year Rule, which means inherited retirement accounts need to be distributed within 10 years. For beneficiaries who inherit these accounts while still in their prime earning years, they need to plan wisely for their distributions which could push them into a higher tax bracket.
As a result of this change, many IRA owners are now exploring planning strategies to help maximize the after-tax value of their legacy, including using Roth conversions. While inherited Roth IRAs will still have to be distributed according to the 10-Year Rule, owners will minimize the tax burden on their heirs in the future by paying the taxes now.
CARES Act (2020)
On March 27, 2020, the CARES Act was signed into law. The more than $2 trillion relief package was created to provide economic support and financial relief to both individuals and businesses impacted by the COVID-19 pandemic. One of the provisions of the Act was that RMDs were waived in 2020. Normally, you cannot take your RMD and convert it to a tax-free asset but, because of provisions within the CARES Act, anyone normally subject to RMDs can withdraw money from their traditional IRA and convert it to a Roth IRA. This exception only applies to 2020, so anyone considering taking advantage of this provision must do so by Dec. 31, 2020.
Considerations for Roth Conversions
When considering a Roth conversion, you should always speak to your CPA and/or financial advisor as every situation is unique, and the decision making is complex. General considerations include:
- Current and future tax bracket
- Outside funds to pay the taxes owed on the conversion
- Length of time for the invested funds grow
- Amount required to meet your annual living expenses after retirement
- Favorable tax attributes to offset conversion income
- Plans to leave a charitable bequest
- Length of time for your beneficiaries to wait before accessing funds upon your passing
- Plans to utilize your Unified Credit of Goods and Services (GST) exemption with IRA assets
Due to the nature of a Roth conversion, your current and future tax brackets will be a large factor in your decision. With a traditional IRA, you are taxed with each distribution of funds from your account and with a Roth, you are taxed for the entire amount you convert at the time of the conversion. If you are currently in a high tax bracket but anticipate being in a lower tax bracket once in retirement, a traditional IRA will potentially make more sense as you could possibly pay less taxes overall. In addition, the taxes on a Roth conversion have the potential to be substantial, and not everyone has outside funds to offset the taxes on the conversion.
There is no definitive conversion amount that will work for every individual simply because everyone has different financial situations, goals and lifestyles. However, partial or micro conversions generally provide a better quantitative result over total conversions.
Additionally, conversions should be done while married, if possible. The federal tax bracket is more favorable for married couples filing joint tax returns over single individuals. There are benefits for filing prior to a spouse’s death, including the deferral of required minimum distributions until the age the account owner would have reached 72.
Given the tax environment we are in currently, and ongoing uncertainty as to how long tax rates will stay as low as they are, now is an excellent time to consider a Roth conversion.
When you factor in the temporary elimination of RMDs for 2020 and the implementation of the 10-Year Rule for inheriting IRAs, Roth conversions are an especially attractive planning tool this year.
All decisions regarding retirement accounts and potential conversions should be discussed with a CPA or financial planner. If you would like additional information or questions, reach out to DHG Wealth Advisors team at email@example.com.
 Internal Revenue Service, www.irs.gov.
 The previous age for RMDs was 70 ½ years old.
 Tax Foundation, www.taxfoundation.org.
The information in this article should not be considered investment advice to you, nor an offer to buy or sell any securities or financial instruments. The services, or investment strategies mentioned above may not be available to, or suitable, for you. Consult a financial advisor or tax professional before implementing any investment, tax or other strategy mentioned herein. The information herein is believed to be accurate as of the time it is presented and it may become inaccurate or outdated with the passage of time. Past performance does not guarantee future performance. All investments may lose money.