Advisor Flipbooks

Can we talk about Roth conversions? Roth conversions are a hot topic given the potential tax law changes, and they should be a point of discussion with your clients this year. Whether your clients do a conversion depends on several factors. Why consider a Roth conversion? Roth IRA distributions can be withdrawn tax-free in certain circumstances. 1 Having access to tax-free cash in retirement helps keep the tax temperature from getting too hot even if tax rates increase. A Roth IRA will also compound income tax-free for beneficiaries. Those inheriting a Roth IRA could let tax compounding continue for 10 years in most cases. Roth IRAs remove the uncertainty of what future tax rates will be, and if rates increase, Roth IRA income will be more valuable. Roth IRAs have a required minimum distribution (RMD) benefit, which is no RMDs during the owner's lifetime. 2 Also, a spouse can roll over an inherited IRA to their own Roth IRA and continue the RMD benefit. For additional information, read our brochure, "10 Reasons to Consider a Roth Conversion." When can a Roth conversion make tax sense? A Roth conversion refers to taking all or part of the balance of an existing traditional IRA and moving it into a Roth IRA. Moving pre-tax money (traditional IRA) to an after-tax account (Roth IRA) can come at a tax cost. So, the question is: When does the Roth conversion make tax sense? 1 Qualified Roth distributions are tax-free if: • Held for five years since the first Roth conversion or contribution; and • Age 59 ½, or • Disabled, or • Death (paid to a beneficiary), or • First-time homebuyer – Up to a $10,000 lifetime limit 2 Beneficiaries must take distributions The most important consideration in deciding if a Roth conversion makes sense is the taxpayer's current federal and state tax rates and their future tax rates. Simply stated, if the taxpayer thinks that their rates will be the same or higher in the future, a Roth IRA may be better. Other factors, such as the time the money is invested, inflation or asset allocation, do not matter. It's all about the tax rates. Note that each conversion amount has its own five-year period to determine when principal will be penalty-free. Sample assumptions The traditional IRA balance is all pre-tax, and the 30% tax rate is constant throughout the illustration. No Roth Conversion $250,000 traditional IRA balance $250,000 X3 (triples in value over lifetime) $750,000 Less 30% (federal and state tax combined rate) -$225,000 Net $525,000 With Roth Conversion $250,000 traditional IRA balance $250,000 Less 30% tax -$75,000 X3 (triples in value over lifetime) $175,000 Net $525,000 For illustrative purposes only. As you can see, the net return is the same if the tax rates are the same. If tax rates increase, the Roth IRA advantage compounds over time. Since the future is uncertain, having some Roth assets makes sense from a tax-rate hedging standpoint. Also, if your intention is to leave your IRA to your beneficiaries, consider the tax rates of the beneficiary who would be inheriting the IRA.

• Cover