Aug. 2018 – The Roth Conversion

Short term changes in stock prices are neither predictable nor within your control, so there is little point in spending time trying to pick stocks or forecast the market. Tax planning, however, is well within your control. Investors who have significant IRA or 401(k) account balances as they approach or enter retirement should review the potential costs and benefits of a Roth IRA conversion.

We described Roth conversions in detail in the January 2018 Investment Guide. Withdrawals from a traditional IRA or 401(k) are fully taxable as current income. Withdrawals from Roth IRAs in retirement, however, are entirely tax-free. For many, a conversion from a traditional IRA to a Roth IRA may offer a significant opportunity to boost after-tax income and long-term wealth, and improve legacy planning.

A Roth conversion requires investors to pay income taxes today in exchange for tax-free withdrawals in retirement (or for one’s heirs). Beginning this year, federal income tax brackets were reduced. All else equal, this makes Roth conversions more appealing. But the new tax brackets include two significant “jumps”, one from 12 percent to 22 percent and another from 24 percent to 32 percent, that can alter the calculus involved in this decision.

As an example, early retirees who are not yet collecting Social Security or taking required minimum distributions (which start at age 70 ½) may have only modest taxable income. Married couples with income below $77,400 are in the 12 percent tax bracket, which “jumps” to 22 percent at for income above this threshold. If a married couple has $20,000 taxable income during those early retirement years, there is a strong case to be made for them to convert $57,400 per year from traditional to Roth IRAs in order to “fill up” the 12 percent tax bracket. Once they reach age 70 and receive RMDs and Social Security, they may well be facing the 22 percent levy.

The conversion decision should consider other investor-specific factors, which include: Age – generally, the younger you are the more attractive a Roth conversion becomes.

Objectives – Roth conversions can be especially attractive to investors who emphasize a legacy for their heirs.

Tax Risk – the direction and magnitude of future tax rates changes are unknown. The best defense is to

diversify, by holding both traditional and Roth accounts, but the optimal funding level of each is highly

investor-specific.

Tax Funding – Conversions are more costly for investors who must fund conversion taxes due from the IRA itself rather than from cash on hand.

These are just a few factors to consider when contemplating a Roth conversion. We routinely help investors to narrow down the factors relevant to their particular situation and help them form a rational decision framework. For a no obligation discussion of your situation, contact us at 413-645-3327.

Also In This Issue:
Bad News on the Doorstep: Now What?
Mellenials and the Power of Compound Interest
Policy Trajectory and Investor Expectations
The High Yield Dow Investment Strategy
Recent Market Statistics 
Dow Jones Industrials Ranked By Yield
Asset Class Investment Vehicles

To read more, subscribe to the Investment Guide. If you are a current subscriber, you will see Dowload and View buttons on the bottom of the page to access the entire issue.