Roth IRA Conversions in the New Tax Era

Roth IRAs have long been a wonderful retirement savings vehicle. Since their inception in 1997, Roth IRAs have been popular for their tax-free withdrawals, provided certain conditions are met. The new tax legislation taking effect in 2018 does not change the fundamentals of Roth IRAs, but there are two updates to be aware of that might affect doing a Roth IRA conversion.

A conversion from a traditional IRA to a Roth IRA is a strategy whereby an account owner chooses to pay Uncle Sam now on a previously untaxed traditional IRA balance, which allows the money to flow into a Roth IRA for future tax-free withdrawals. A conversion could be done for all or just part of a traditional IRA balance. Sometimes they are spread out across multiple years to be most tax efficient.

By way of background: A traditional IRA generally provides a tax deduction in the year contributions are made, but taxes are due upon withdrawal. Contributions into a Roth IRA do not provide a tax deduction, but the account is not taxed when withdrawals are made in retirement. Also, Roth IRAs do not have required minimum distributions like traditional IRAs, meaning the account owner does not have to begin withdrawing money at age 70.5 if they do not want or need.

New Income Tax Rates

The individual income tax rates have changed beginning in 2018 under the Tax Cuts & Jobs Act. Many Americans will find themselves paying federal income taxes at a lower rate than last year. This might be a good reason to do a Roth conversion. All else being equal, the extra income triggered by the conversion might be taxable at a lower rate.

Roth conversions are not for everyone. The best candidates for the Roth conversion strategy are people who believe that their tax rates during retirement will be the same or higher than their current tax rates. It does not work as well for people who anticipate paying a lower tax rate during retirement.

No Reversing a Roth Conversion

Before 2018, the IRS allowed a “recharacterization” if the account owner changed their mind after doing a Roth conversion, wishing to reverse it back into a traditional IRA. The new tax legislation eliminates that option. Ill-advised conversions in 2018 and beyond cannot be reversed.

Under prior law, you had until October 15 of the year after an ill-advised conversion to reverse it and thereby avoid the conversion tax hit. 2017 conversions can still be reversed. The IRS has clarified that if you converted a traditional IRA into a Roth account in 2017, you can reverse the conversion as long as you get it done by 10/15/18.

The above points are simply highlights to consider. We encourage you to speak with your tax adviser or CPA before making decisions about your individual situation. Please let us know if we can help in any way.

Article adapted from a March 2018 MarketWatch article.

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