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It's Roth IRA Conversion Season

Posted April 21, 2020 by John Posey

As I write this, the S&P 500 index is near 2,745 which is roughly 19% lower than the historical peak hit earlier this year. Just about a month ago, the S&P 500 was down nearly 35% from the high. To say a lot has happened in a month’s time might be an understatement. From a financial planning perspective, there is an idea I think is worth chewing on right now – a Roth IRA conversion. To the extent you have IRAs or retirement plans that are not Roth plans, I think you’d be wise to look into it. Even if your only retirement account is in an employer-sponsored plan, it is possible you may be able to accomplish an in-service distribution to a rollover IRA depending on your plan’s rules (ask your human resources manager).

Roth conversions can be beneficial at any time, but times like right now when equity values are depressed allow you to convert more shares at a lower price. That’s why we’re in Roth IRA Conversion Season. This is a strategy to pay less in taxes than you may have otherwise by paying tax on a lower value that often represents a temporary decline in a long-term appreciating asset.  In essence, you are moving your money from one pocket to another so to speak, which results in some unique tax benefits. Once IRA funds are converted to a Roth IRA, it has the opportunity to grow tax-free and a subsequent rebound in values will become tax-free growth to you. Roth IRAs grow tax-free and once you surpass age 59 ½ it’s all available to you tax-free. Also, there is no required minimum distribution requirement for Roth IRAs as generally applicable to traditional IRAs after reaching age 72.

Now you might saying, “Tax-free growth? Sign me up!” Here’s the other part of the story: any amount you convert to a Roth IRA is subject to ordinary income tax in the calendar year you complete it. You’ll be paying tax on the amount you convert come tax time. Now don’t let that fact rain on your parade just yet. This is where doing some tax planning becomes important. You need to have an understanding of where you are falling in the marginal tax brackets so you can project how this may affect your tax situation. Using a strategy I refer to as “tax bracket management”, I would attempt to project what your taxable income will be and then evaluate how a Roth conversion could affect your situation. The objective is to convert an amount that minimizes potential adverse tax effects such as moving into a higher tax bracket. Sometimes recognizing a higher income can have unintended consequences like a Medicare premium increase or other tax benefits possibly forgone if not planned with these things in mind. Roth conversions can work out beautifully in years where you may not be recognizing as much income as usual because you retired, semi-retired or maybe have an income that fluctuates from year to year for example.

Not sure where to start in evaluating your tax situation? I’d suggest you consult your accountant or a CPA (Certified Public Accountant) on the topic. Also, Plains Advisory has the ability to review tax returns and provide projections for informational and planning purposes so you may better evaluate the Roth conversion opportunity. All Plains Advisory clients are encouraged to provide their most recent tax return to us so we can provide this planning service – it’s just part of the package so you just as well take advantage of it.

The final reason I think a Roth conversion is worth a thought right now is because tax rates are historically low. It may make sense to recognize some more income at current tax rates and pay some taxes now, particularly if you’re in one of the lower tax brackets.  Of course, no one knows exactly what the future holds in terms of tax rates, but I have a harder time expecting they will go a lot lower. I believe Roth conversions are just one of the ways we can tip the scale in our favor to realizing better lifetime financial outcomes which is what really matters. It just takes a little effort and opportunistic thinking to make it happen.

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Advisory services offered through Plains Advisory LLC, an investment adviser registered with the State of Nebraska. Insurance products and services are offered and sold separately through John Posey, a licensed insurance agent. No investment strategy can guarantee a profit or protect against loss in periods of declining values. Opinions expressed are subject to change without notice and are not intended as investment advice or to predict future performance. Past performance does not guarantee future results. Consult your financial professional before making any investment decision.

Any information provided is designed to provide general information on the subjects covered, it is not, however, intended to provide specific legal, tax, financial or investing advice and cannot be used to avoid tax penalties or to promote, market, or recommend any plan or arrangement. Please note that Plains Advisory LLC does not give legal advice. You are encouraged to consult an attorney.