Financial Planning Matters: Roth IRA Conversion: Protecting Retirement Assets from Rising Tax Rates


Steve Kohler, CFP®, CPFA and Nancy Kunz, CFP®, ChFC®, CLU®


President Biden has made it clear that tax reform under his administration will impact wealthier Americans. Even though many of these changes will not impact higher-income Americans until the 2022 tax year, now is a good time to begin thinking about how to protect retirement assets. It may also be a good time to convert money and pay taxes at current levels, rather than gamble on potentially higher tax rates in the future.


Roth IRA Conversion


A Roth IRA conversion is a useful technique to reduce the impact of rising taxes. The process begins with the review of your tax return and identifying any triggers that warrant a possible conversion. If you are nearing or at retirement age, there may be merit in moving assets from a traditional IRA or 401(k) plan to a Roth Individual Retirement Account due to the tax-free income it will deliver in your later years.


When a Roth Conversion Makes Sense


One of the important considerations in converting to a Roth include Medicare expenses. For example, this year a 72-year-old with $1.5 million in a Traditional IRA will have an RMD (Required Minimum Distribution) of $58,593.75. The RMD is considered earned income and creates additional expenses for Medicare. This impact may be substantial. For example, moving income brackets from $176,000 to $176,001 triggers a 40% increase in monthly Medicare premiums. If the RMD was smaller, income levels could be lower and therefore lead to lower Medicare expenses.

Other situations when a Roth conversion may make sense include relocations, early retirement and small-business owners looking to better capitalize on the 20% pass-through deduction.


Unlike traditional IRAs, where distributions are fully income-taxable, a Roth generally allows for tax-free distributions once you reach age 59½ and have held the Roth IRA for five years. They also come with no required minimum distributions during your lifetime, allowing additional years of compounding investment returns.


How to Convert to a Roth

Roth conversions became a popular topic last year when an unexpected opportunity arose from the CARES (Coronavirus Aid Relief and Economic Security) Act. The legislation allowed eligible clients to suspend required minimum distributions for tax year 2020, creating a window in which they could instead convert that money into after-tax Roth accounts at a historically low tax rate. However, the RMD relief ended with the close of the 2020 year.

The new administration’s tax proposals now again incentivize moving funds into a Roth IRA. Converting to a Roth IRA can be achieved in the following ways:

  • Indirect rollover: You receive a distribution from a traditional IRA and contribute it to a Roth IRA within 60 days.

  • Trustee-to-trustee or direct rollover: You tell the financial institution holding your traditional IRA assets to transfer an amount directly to the trustee of your Roth IRA at a different financial institution.

  • Same trustee transfer: If your traditional and Roth IRAs are maintained at the same financial institution, you can tell the trustee to transfer an amount from your traditional IRA to your Roth IRA.


The “Backdoor” Roth Conversion


Under current rules, a Roth IRA cannot be opened or contributed to if one’s modified adjusted gross income is greater than $139,000 in 2020 ($140,000 in 2021) for single filers and $206,000 in 2020 ($208,000 in 2021) if married and filing jointly. A solution to this for high-income earners could be to explore a ‘backdoor’ Roth IRA. A ‘backdoor’ Roth IRA is a legal workaround by which high-income earners can circumvent income limits.


To begin the process, one must make a nondeductible contribution to a traditional IRA. Once completed, that contribution to the traditional IRA can be converted into a Roth IRA shortly thereafter. The annual contribution limit for a Roth IRA is $6,000 ($7,000 if you're age 50-plus). By scooting through the back door every year, you can potentially build up a tax-free retirement nest egg over time and enjoy the Roth IRA's unique benefits.


Adding it All Up


Depending on individual tax situations, the financial benefits of a Roth conversion may be substantial as after-tax investments can compound over a period of years, or decades. Given the likelihood of potential changes in tax legislation, especially on higher-income earners, the protection provided by a Roth conversion a Roth Conversion may be an appropriate financial planning technique to consider.


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Steven Kohler, CFP®, CPFA

Senior Financial Advisor

Financial Planning Chair

skohler@dbroot.com


Nancy Kunz, CFP®, ChFC®, CLU®

Financial Advisor

nkunz@dbroot.com


This material has been provided for general, informational purposes only, represents only a summary of the topics discussed, and is not suitable for everyone. The information contained herein should not be construed as personalized investment advice or recommendations. Rather, they simply reflect the opinions and views of the author. D. B. Root & Company, LLC. does not provide legal, tax, or accounting advice. Before making decisions with legal, tax, or accounting ramifications, you should consult appropriate professionals for advice that is specific to your situation. There can be no assurance that any particular strategy or investment will prove profitable. This document contains information derived from third party sources. Although we believe these third-party sources to be reliable, we make no representations as to the accuracy or completeness of any information derived from such sources, and take no responsibility therefore. This document contains certain forward-looking statements signaled by words such as "anticipate," "expect", or "believe" that indicate future possibilities. Due to known and unknown risks, other uncertainties and factors, actual results may differ materially from the expectations portrayed in such forward-looking statements. As such, there is no guarantee that the expectations, beliefs, views

and opinions expressed in this document will come to pass. Information presented herein is subject to change without notice and should not be considered as a solicitation to buy or sell any security.

All investment strategies have the potential for profit or loss. Asset allocation and diversification do not ensure or guarantee better performance and cannot eliminate the risk of investment losses.

The impact of the outbreak of COVID-19 on the economy is highly uncertain. Valuations and economic data may change more rapidly and significantly than under standard market conditions. COVID-19 has and will continue based on economic forecasts to have a material impact on the US and global economy for an unknown period.


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