Much has been written about the benefits of converting retire- ment assets in a traditionalIRA to a Roth IRA. During 2020, Roth conversions received a lot of favorable presswith tax rates being low and the stockmarket being depressed for part of 2020.
This is a retirement savings strategythat might be beneficial for some of yourclients, but it should be looked at on acase-by-case basis to determine if it is agood fit for a particular client.
WHAT IS A ROTH IRA CONVERSION?
In a Roth IRA conversion, the account
holder takes some or all of the balance
in their traditional individual retirement
account and converts that money to a
Roth IRA. The money converted to a Roth
IRA is taxable as ordinary income in the
year the conversion is made. The excep-
tion is the value of any after-tax contribu-
tions made to the traditional IRA that are
part of the amount converted.
Another possible type of a Roth IRAconversion might occur if your clientis leaving their employer. A traditional 401(k) account can be rolled overand converted to a Roth IRA. The taxrules described above will still apply.Depending upon the rules of both theclient’s 401(k) plan and those of the IRAcustodian, an interim transfer to a traditional IRA may be required.
Once a Roth IRA conversion is completed, distributions from the accountare tax-free as long as certain requirements are met.
ROTH IRA CONVERSIONS, RMDs
Notwithstanding the required minimumdistribution waiver in effect for 2020,any RMDs for the year must be takenfirst, and the amount cannot be converted to a Roth IRA.
Also, any gains on the investments inthe account, regardless of whether thecontributions were made on a pretax orafter-tax basis, are subject to taxes in aRoth conversion.
It’s important to be sure that yourclient has sufficient cash outside of thetraditional IRA to cover the taxes onthe Roth conversion. If they need to taptheir traditional IRA to cover the taxbill, these withdrawals will be subject totaxes and potentially to a 10% penalty ifthe client is younger than 59 ½.
HOW IS A ROTH IRA
Roth IRAs are not subject to RMDs. Forclients who don’t need the RMD incomein retirement, this can result in tax savings each year. Additionally, this allowsthe value of the account to remain intactand potentially continue to grow overtime. A Roth IRA also can be a powerful estate planning vehicle for leavingmoney to a spouse or other heirs.
It also can provide your client with taxdiversification in retirement and a RothIRA conversion can act as a hedge againstfuture tax rate hikes. Having retirementsavings in both Roth and traditional
Roth IRA Conversions: What
Advisors Need to Know
Here’s how this retirement planning tacticinteracts with RMDs and taxes, as well as somestrategies to use.
RETIREMENT PLANNINGBy Roger Wohlner