We have all heard and agree that the Roth IRA can be a valuable strategy for retirement, considering the future tax-free withdrawals. The tax-free withdrawals require you to have reached the age of 59 ½ and held the account for five years or more. In the past, we talked about one strategy of converting money to a Roth IRA if you make more than the income (AGI) limit to contribute directly to a Roth each year. Please see our previous blog for that strategy.
A Roth conversion can be beneficial in other circumstances as well and the ability to take advantage of these benefits just increased under the recent “Tax Cuts and Jobs Act” (TCJA) of 2017.
One of our specialties is creating a cash flow strategy for our clients as they retire and look to start taking distributions. This cash flow strategy looks to optimize withdrawals from your various accounts, including anticipating your future required minimum distributions (RMDs). For many of our clients, we foresee their RMDs exceeding their cash flow needs in the future with the risk that will come at a time of higher tax rates.
As a result, it might make sense to look at converting some of their pre-tax IRA money to a Roth IRA. Essentially, you are paying the tax now so that you will not be required to take it out at age 70 ½ and potentially pay even more taxes on it later. For example, for a couple who has just retired but not reached age 70 ½ yet, they could use up some of their tax bracket now by converting some of their IRA money to Roth IRA assets. Then, when social security starts and RMDs are required, they will not have to withdraw as much from their IRAs since Roth IRAs are not subject to RMDs.
Here is where TCJA comes into play. For that same couple mentioned above, if they were to convert some of their IRA money now while taxes are even lower then they have been historically, they may save even more money in the future if tax rates increase after the sunset expected in 2025 for individual tax rates. This can be an annual strategy for as many years as makes sense in each situation.
One of the caveats to this opportunity is that TCJA took away the ability for you to reverse a Roth conversion in the future if you determine that it was not advantageous for you. This means that it is even more important to consult your tax advisor when considering a Roth conversion strategy. Part of our process is to work closely with our clients’ tax advisors to make sure that this is the optimal strategy for the client and that the right amount is converted.
Thanks to TCJA, we are in an ideal environment for Roth conversions.
Kim Butler, CFP®