This year may be an opportunistic time for you to convert some or all of your traditional IRA to a Roth IRA. Stock markets around the world are down, which may provide an opportunity to shield future stock appreciation from taxes by moving assets from a traditional IRA to a Roth IRA. The relief offered by the suspension of the Required Minimum Distribution (RMD) in 2020 may lower your taxable income this year, making the tax impact from the conversion less burdensome.

Roth IRAs vs. Traditional IRAs

Contributions to traditional (deductible) IRAs are made with pretax dollars.  The growth is tax deferred, but the entire distribution is taxable. Contributions to Roth IRAs are made with after tax dollars. The growth and the distributions are tax free as long as you have reached age 59 ½ and have had your Roth IRA for at least 5 years. A conversion from a traditional IRA to a Roth IRA is subject to income tax.

Advantages of Roth IRA Conversions

The goal of a Roth IRA conversion is to eliminate tax on any future growth in the converted assets. However, since the conversion is a taxable event, you want a strategy to minimize taxes on the conversion. In today’s world, with your IRA portfolio likely down due to market conditions and income taxes at historically low rates, now may be the time to implement that strategy.

Since conversions are taxable, it is often appropriate to perform small conversions year after year, thus spreading out the tax liability. Due to the unique circumstances of 2020, if you are in the habit of doing small annual conversions, you may want to consider a larger conversion this year. Also consider that selectively converting a portion of your traditional IRA lowers the amount in that IRA, which also lowers your future RMDs.

For estate planning purposes, under the SECURE Act, non-spouse beneficiaries must drain their inherited IRAs within ten years, thus creating taxable income for traditional IRA beneficiaries. A Roth conversion eliminates tax on the beneficiary IRA to the extent of the conversion, however a comparison between income tax rates of the IRA owner and beneficiary need to be considered when making the decision to convert.

Please remember that it is most beneficial to pay the taxes on the conversion from sources outside of the IRA.

Ask the Experts

There are other details that need to be considered before you convert your traditional IRA to a Roth IRA. Consult with your Impact Capital advisor to determine how these changes could affect you. For more information, call 301-417-3300.