Plans change because scenarios and conditions change. While you have a strategy for your financial future and legacy, that planning will inevitably have to be adjusted for any number of circumstances, including your personal preferences and needs, market fluctuation and, as we will focus on in this commentary, Washington D.C.
Because administrations, legislatures and political philosophies come and go, tax policy changes. In fact, there’s an old saying “tax code is written in pencil.” There is a strong indication that taxes will increase in the future, so including a Roth IRA conversion in your financial plan today may help you protect more of your wealth in your lifetime, and preserve the after-tax value of your legacy for your heirs.
The present situation
While you may consider the current top tax bracket of 37 percent high, historically, that percentage is relatively low. For instance, from the late 1940s through the 1960s, the top marginal tax rates were around 90 percent and there was not a significant decrease until 1987 when marginal tax rates dropped to just below 40 percent.
Higher taxes coming?
Tax reform is still being negotiated in Congress, but many expect taxes to go up. The White House has proposed increasing the top tax rate back to 39.6 percent. If and when taxes do go up, converting your traditional IRA, or even a portion of your traditional IRA, to a Roth before the increase could prove beneficial because you would be taxed at a lower rate now – before the increase – than you would if you waited or did nothing.
Another current factor impacting the consideration for a Roth conversion is the Setting Every Community Up for Retirement Enhancement (SECURE) Act. Signed into law in 2019, the SECURE Act evolved the rules for the transfer of wealth. Previously, wealth could be accumulated and grown tax-deferred, and then passed onto your heirs in such way that allowed them to stretch that inheritance out over their lifetimes — without a significant tax penalty.
However, the SECURE Act did away with the “stretch IRA” for most non-spousal beneficiaries, and instead they are subject to the “10-year rule” which requires that inherited IRAs must be fully distributed by the end of the 10th year. This could negatively impact the after-tax value for your heirs. Not only may the money you pass on not last for your heirs’ lifetimes, but there may not be money to pass on to further generations. In addition, your heirs might be at the peak of their earning potential when they inherit your IRA – meaning their distributions will be taxed at potentially higher rates.
It’s also important to note that when heirs inherit a traditional IRA, they are not allowed to convert that IRA to a Roth, so if you are concerned about creating a tax liability for your beneficiaries, you would be well served to consider a Roth conversion today.
This combination of the current tax rates and the changes to wealth transfer that resulted from the SECURE Act is why you might consider converting your traditional IRA to a Roth IRA. Your benefits could include:
- Tax savings over time
- Long-term tax-free growth of assets – your Roth distributions are not taxed
- No Required Minimum Distributions
- Preservation of after-tax value of your legacy wealth
- Minimization of tax burdens for your heirs
- The ability to lock in tax rates now and shield your wealth from future tax law changes
Of course, converting to a Roth IRA means you will have a tax bill today, and how you pay those taxes is an important consideration when deciding whether to convert or not. It is recommended that you pay the taxes from cash or other taxable funds – and not from the IRA that you are converting. And remember – you don’t have to convert your entire balance at once. You can convert an amount that makes sense based on your financial plan.
As you weigh your decision with your wealth advisor, these are the factors you will have to keep in mind:
- Will you need your IRA for living expenses? For how long?
- The tax rate differential between conversion and distribution
- The availability of non-IRA, taxable funds to pay conversion taxes
- Your estate tax scenario
- Your peace of mind
Also keep in mind that, should you convert your traditional IRA to a Roth, there is no going back. You must stick with your decision, so talk with your advisor and accountant to ensure you have a comprehensive understanding of your choice.
Your peace of mind. Our priority.
Just as your goals are unique to you and your family, your financial plan should reflect that uniqueness. DHG Wealth Advisors welcome the opportunity to review your current plan and goals and help you determine if a Roth IRA conversion will best help you achieve your vision. Together, we can determine your options for how you may want to evolve your strategy.
Getting started is as easy as connecting with one of our professionals.
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 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. This information was provided by Broadridge Investor Communications Solutions, Inc.