Robert M. Olsen, AIF®, CLTC®
by Robert M. Olsen, AIF®, CLTC®

When is a good time to review your IRA for a Roth conversion? The best answer might have been 12 years ago when conversions became allowed and were signed into law with the Small Business Jobs and Credit Act of 2010 – but today may also be an opportunity with the market down and you still have time to consider before the 2022 calendar year-end.

Assets invested in your IRA have been growing tax deferred since you contributed to the account. Knowing that your dollars are predestined to be taxed later in life (see our RMD planning commentary from November 7) at your future tax bracket, a Roth conversion may be worth considering if your tax bracket today is lower than what it may be in the future.  This is often the case for folks who retire before starting the Social Security retirement benefits and before IRA required minimum distributions kick-in at age 72.

What is a Roth conversion?  It is the process of transferring traditional IRA assets (or assets in an employer plan like a 401(k), 403(b), or 457 plan) to a Roth IRA.  Any amount that you transfer typically counts as taxable income and requires paying income taxes on the amount you convert in the year that you convert.  Once in the Roth IRA, the transferred assets can continue to grow on a tax-deferred basis and, most importantly, can be withdrawn or distributed tax-free.

Is a Roth conversion a good idea?  The real answer is that it depends.  A key benefit of completing a Roth IRA conversion is that it can potentially lower your income taxes in future years by allowing you to choose between taxable vs. tax-free distributions.  Holistically looking at where your income tax bracket is likely to trend over the course of your retirement with your advisor will help, and is somewhat necessary, to put the benefits of a Roth IRA conversion into context.

For some, Roth conversions are not going to provide a material benefit during their lifetime.  But for those who have cash available to pay the conversion income taxes and whose retirement income is not materially impacted by doing conversions, the focus may be more on their legacy in that Roth IRA assets are not taxed when your heirs inherit them.  Traditional IRA assets will be taxed and within 10 years for most under current tax laws.  The bottom line is that either you pay the taxes on your IRA during your lifetime, or your kids will have to within 10 years of inheriting it from you, so tax-free Roth IRA assets are much better to leave to your kids if you can swing it.

While converting some dollar amount from your IRA to a Roth IRA account can be seen as a tactical move with assets values down in 2022, it may also be strategically smart longer-term for five good reasons:

  1. IRMAA (Income-Related Monthly Adjustment Amount): If you are still under age 65, then Roth conversions may help. You may be able to limit your exposure to IRMAA later in life when additional Medicare related premiums may be required based on your income.

2023 IRMAA Brackets

(based on 2021 Modified Adjusted Gross Income)

For 2023, the above surcharges are added to your base Medicare Part B ($164.90) & Part D (depends on your plan) monthly premiums if your 2021 income falls within the above brackets.  Having a Roth IRA to withdraw from, using tax free Roth IRA dollars, may help you to proactively plan to duck under the projected surcharge brackets throughout your retirement.

  1. Income tax bracket planning: If you anticipate being in a lower than typical tax bracket for 2022 because of time away from work or pause in employment, then you may be able to take advantage of filling up lower tax brackets by converting IRA assets to a Roth IRA while your income is low vs. considering a Roth IRA conversion later on when you’re back to work and converting would push you in a higher bracket.

The conventional wisdom is that we expect to be in a lower tax bracket in retirement when our earned income stops, but this is not always the case.  For those with significant retirement assets, the onset of required minimum distributions at age 72 may result in a significant increase in taxable income, pushing you into a higher income tax bracket (as well as a higher IRMAA bracket).  For surviving spouses who have to file singly at the compressed Single income tax brackets above, their tax situation typically gets even worse when they inherit a large IRA (and therefore the annual required minimum distributions) from their spouse.

  1. Ordinary losses: If you are expecting your 2022 tax filing to have “ordinary” losses (not capital gain losses) or if you have historical loss carry-forwards, of particular interest for business owners, such losses can be used to offset, dollar for dollar, any reportable income from Roth IRA conversions completed before December 31st.  Utilizing current or historical ordinary losses can neutralize the tax implications of a Roth conversion. Do seek the council of your business tax professional to determine if such a strategy is applicable in your situation.
  2. Flexible Distributions: As mentioned above, having dollars in a Roth IRA account, as an accompaniment to your IRA account, gives you, and your ACM advisor, more flexibility when attempting to meet your retirement cash flow needs. Depending on each individual’s situation, their retirement needs, and tax picture, having the ability to draw from a tax free bucket (Roth IRA) in tandem with a taxable bucket (IRA) allows for greater levels of tax and income optimization.
  3. RMD freedom:  Roth IRA dollars are not subject to the Required Minimum Distribution (RMD) rules of the IRS upon reaching age 72, unlike their traditional IRA counterpart. The IRS requires distributions from your IRA, starting at age 72. And every. Year. Moving. Forward. In your life. So, consider the alternative with a conversion to Roth and break free of the annual RMD cycle.

We believe that Roth IRA conversions are an important consideration for retirement planning.  Whether or not it makes sense for you depends on your particular situation.  As always, if you have questions, please reach out to your ACM Wealth Advisor to review whether a Roth IRA conversion may make sense and how it may impact you or your family.

We’ll follow up next week with more year-end planning tips.

The foregoing content reflects the opinions of Advisors Capital Management, LLC and is subject to change at any time without notice. Content provided herein is for informational purposes only and should not be used or construed as investment advice or a recommendation regarding the purchase or sale of any security. There is no guarantee that the statements, opinions or forecasts provided herein will prove to be correct. Past performance may not be indicative of future results. Indices are not available for direct investment. Any investor who attempts to mimic the performance of an index would incur fees and expenses which would reduce returns. Securities investing involves risk, including the potential for loss of principal. There is no assurance that any investment plan or strategy will be successful.