One day a forward-thinking couple arrived in my office with a plan. They wanted to bequeath the bulk of the money in an IRA to their two children, and they also wanted the children to receive that money tax free.
Nice idea, so together we set about crafting a strategy that would help make it happen.
Here’s how: Bit by bit, we are converting money from their traditional IRA into a Roth IRA. Each year we will make conversions, but doing so while being careful in any given year not to bump the couple above their 24% marginal tax bracket, which for 2021 is up to $329,850 in taxable income for a married couple filing jointly.
Yes, they must pay the taxes on any amount moved from the traditional IRA to the Roth, but once the funds arrive safely in the Roth, their savings can grow tax free. Under the SECURE Act, their children can defer any distributions from the inherited Roth IRA until year 10, allowing the money to continue to grow tax free that entire time. And the children won’t be taxed on the distributions when they do take them.
This couple established for themselves a mission that included their children’s future, and they are well on their way to being able to say: “Mission accomplished.”
Why Now Is a Popular Time to Make a Roth Conversion
Financial professionals talk a lot these days about Roth conversions such as the one my clients are using, and with good reason. These conversions are a great tool for reducing future tax liability, and now is an opportune time to take advantage of them. The tax reductions for individuals that came about with the Tax Cuts and Jobs Act of 2017 are set to expire at the end of 2025.
That means, short of some last-minute congressional action, taxes will go back up in 2026. You will still be able to do a Roth conversion, but the taxes you pay when you move the money from a traditional IRA are likely to be higher.
So, if you are a good candidate for a conversion, the time is ripe to act before the tax rate jumps back up.
Some Folks Who May Be Good Candidates
But, you might ask, what kind of person best benefits from a Roth conversion? Among those who should consider converting to a Roth are:
- Anyone who feels that when they retire they will have income that puts them in a higher tax bracket than their current bracket. How could that happen? One way is that, when you reach age 72, the IRS requires you to start taking a percentage of your money out of retirement accounts, such as a traditional IRA, in which taxes were deferred. Those withdrawals, when added to your Social Security, pension and any other income you might have, could bump you into a higher tax bracket.
- Anyone between the ages of 60 to 72 who is retired and on a limited income of Social Security. Why the cutoff at age 72? That’s the age you must start taking those required minimum distributions, and IRS rules don’t allow you to convert RMDs to a Roth, so ideally you want to get the job done before you reach that magic age.
- Investors like the couple I am working with who want to leave a tax-free legacy behind for their heirs.
Others Who Should Probably Skip This Strategy
Despite all the good you can say about Roth conversions – and there is definitely plenty of good to say – they aren’t for everyone.
I shared with you the story of that couple who wanted to leave IRA money to their children tax free and how a Roth fit perfectly into their plans. But let me tell you a story about another client who had a very different situation, and for whom a Roth conversion did not factor into the solution.
This client had heard about Roth conversions and about a year ago asked me about doing one. When I reviewed his tax returns, though, I discovered something interesting. He is retired on disability pay that is not taxable. In fact, he could take money out of his traditional IRA each year and still not owe taxes. Since his major source of income is tax free, he was not a good candidate for a Roth conversion.
Anyone whose income is similarly tax free probably can skip the idea of moving money into a Roth. Others who should not consider a conversion are people with very high incomes who are in their peak earning years. Remember, when you convert money to a Roth IRA, you increase your taxable income for that year.
One other important factor to be aware of and consider is that converting funds from a traditional IRA to a Roth IRA could increase your future Medicare part B premiums. Medicare Part B premium costs are determined by your modified adjusted gross income from two years prior. For 2021 Medicare Part B premium costs range from the low of $148.50 to a high of $504.90. Any Roth conversions done for the tax year 2021 could affect your 2023 premiums.
Ultimately, though, what decides whether you are a good candidate for a Roth conversion is your specific financial situation. To become better informed about what a Roth might mean for you, you should consult a CPA or a Certified Financial Planner.
They should be able to help you make the right move – and avoid the wrong one.
Ronnie Blair contributed to this article.
The appearances in Kiplinger were obtained through a PR program. The columnist received assistance from a public relations firm in preparing this piece for submission to Kiplinger.com. Kiplinger was not compensated in any way.
Mark Kenney is an Investment Adviser Representative with SHP Financial (www.shpfinancial.com (opens in new tab)). He is Series 7 & 66 securities licensed as well as Massachusetts Life and Accident & Health licensed. He has also obtained the CERTIFIED FINANCIAL PLANNER™, or CFP®, certification, and was awarded the only nationally recognized tax designation, CTS™ (Certified Tax Specialist™) by The Institute of Business & Finance.
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