Typically, converting an IRA to a Roth IRA is a fourth quarter conversation with clients, as by then they have a pretty good idea of what their fiscal year will look like closer to the December 31 deadline and any current ( Or the new one to come). Tax laws can affect their decision.
But waiting until the last hour to think and talk about conversions with customers can’t provide enough time to complete an adequate evaluation and task—especially if you have several dozen applicable cases.
So here are some tips to make sure you have enough time to discuss and decide on an IRA-to-Roth IRA conversion.
Why this year?
The key to timing a Roth conversion is when you believe that the rate at which the conversion will be taxed will be lower than when the money is converted or withdrawn in the future.
The tax rate may now be lower for a number of reasons, including whether the client recently retired and gave up earned income or donated a significant amount to a qualified charity or donor-aided fund. And it could be higher by starting Social Security or pension payments in the future, receiving a larger inheritance, realizing a large capital gain on the sale of an asset, or introducing required minimum distributions (RMDs). The rate may also fluctuate based on general changes in state or federal income tax rates or the values of the property itself.
Senior clients have even more variables to consider. Older married couples who file their taxes jointly can now decide to convert while both spouses are alive, because after the death of one, the survivor’s standard deduction will be halved, while the income (such as RMD) and Social Security) may not fall nearly as much. Such customers can still choose to convert if the tax rate today is likely to be lower than the tax rate to be paid by account beneficiaries, when beneficiaries will need to take RMDs from an inherited IRA in the future.
How much?
Typically, the best amount to convert is an amount that takes customers’ total taxable income up to the top of a particular desired tax bracket, and no more. That optimal number will depend on the specific financial situation of customers, but the largest percentage jump in the federal income tax rate for the 2022 tax year is 12% to 22% (at $83,550 for married couples filing jointly, half that for singles). and 24% to 32% (178,150 for married couples, halved for singles).
see gotchas
The effective tax rate on a conversion is the primary — but not the only — factor and potential costs to consider:
- Additional income from the conversion may trigger income tax on customers’ Social Security benefits;
- Customers who are receiving subsidized health care under the Affordable Care Act are required to include the converted amount in income that determines whether they qualify for a subsidy. This calculator can alert them to the potential cost;
- Even customers who receive their health care through Medicare can incur additional costs due to Roth conversion, as the converted amount is higher Medicare for at least a year or two after any conversion. Part B can trigger premiums;
- Customers may also lose certain tax deductions that are phased out at particular taxable income limits; And
- Now customers with little or no taxable income can qualify for a 0% tax rate on any actual long-term capital gains. However, the converted amount may trigger tax on benefits that the customer could have otherwise avoided.
What about Roths from RMDs?
Customers who are over the age of 72 and/or have an inherited IRA will be disappointed to learn that their required minimum distribution amount cannot be converted to a Roth IRA.
RMD or not, no distributions from an inherited IRA can be converted to a Roth IRA. However, IRA owners can convert any amount above their RMD in a given year.
Earned income customers who are receiving an RMD can hopefully offset that distribution by increasing contributions to a pretax IRA or 401(k), which can offset income tax on the RMDs and combine the assets into one account. which can eventually be converted into a Roth IRA. ,
don’t stop
Your firm or custodian can withhold income tax on the converted amount and transfer the taxes to the appropriate state and federal revenue agencies; But it’s better to convert the entire desired amount into a Roth IRA and then pay any attendant taxes with the out-of-pocket money. Just make sure the customer contacts their CPA as soon as possible after the conversion to alert the preparer about the converted amount, who can then respond with an answer as to whether and when estimated taxes are to be paid. Is.
fill out the paperwork first
As soon as you identify the customers for whom a Roth IRA conversion makes sense, and obtain their consent, have them sign and return all the paperwork needed to install the new vehicle (if necessary) and first Transfer the prescribed amount from the end of the year. Then, once clients have a complete picture of their fiscal year, as well as any changes in tax law, they can give you an optimal figure to use instead of starting the whole process at the end of December- Which will be here sooner than you (and your customers) think (or want).
Kevin McKinley is the principal/owner of McKinley Money LLC, an independent registered investment advisor. She . is also the author of Make your child a millionaire (Simon & Schuster).
