Consider a Roth Conversion for Tax-Free Income

The combination of lower tax rates and lower asset values could make this a good time to convert assets from a traditional IRA to a Roth IRA. Converted assets are subject to federal income tax in the year of conversion, which might be a substantial tax bill. But if all conditions are met, the Roth account will incur no further income tax liability for the rest of your lifetime or the lifetimes of your designated beneficiaries, no matter how much growth the account experiences.

Tax Tradeoff

The logic behind deferring taxes on retirement savings is that you may be in a lower tax bracket when you retire, so a current tax deduction might be more appealing than tax-free income in retirement. However, lower rates set by the Tax Cuts and Jobs Act may have changed that calculation for you. A cost-benefit analysis could help determine whether it would be beneficial to pay taxes on some of your IRA assets now rather than in retirement. One strategy is to “fill your tax bracket,” meaning you would convert an asset value that would keep you in the same tax bracket. This requires projecting your income for 2020.


Lower Values, More Shares

If assets in your traditional IRA have lost value, you will pay income taxes on a lower asset base when you convert. As long as your traditional and Roth IRAs are with the same provider, you can typically transfer shares from one account to the other. Thus, when share prices are lower, you could theoretically convert more shares for each taxable dollar and would have more shares in your Roth account to pursue tax-free growth. Of course, there is also a risk that the converted assets will go down in value. You may have the option to take taxes directly out of your converted assets, but this is generally not wise.

Two Time Tests

Roth accounts are subject to two different five-year holding requirements: one related to withdrawals of earnings and the other related to conversions.

For a tax-free and penalty-free withdrawal of earnings, including earnings on converted amounts, a Roth account must meet a five-year holding period beginning on January 1 of the year your first Roth account was opened, and the withdrawal must take place after age 59½ or meet an IRS exception. If you have had a Roth IRA for some time, this may not be an issue, but it could come into play if you open your first Roth IRA for the conversion.

Assets converted to a Roth IRA can be withdrawn free of ordinary income tax at any time (because you paid taxes at the time of the conversion), but a 10% penalty may apply if you withdraw the assets before the end of a different five-year period, which begins on January 1 of the year of each conversion, unless you are age 59½ or another exception applies.

Even if you are close to retirement or already retired, a Roth conversion can make sense to provide tax-free income. Unlike a traditional IRA, Roth IRAs are not subject to required minimum distribution rules during the lifetime of the original owner.* The longer your investments can pursue growth, the more advantageous it may be for you and your beneficiaries to have tax-free withdrawals.

All investing involves risk, including the possible loss of principal, and there is no guarantee that any investment strategy will be successful.

 
New York Life
28380 Highway 75 South Oneonta, AL 35121
Phone: 205-625-5558 Fax: 205-625-5518
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