THE FISCAL BLUE PRINT
WITH COACH JEFF MONTGOMERY
Episode 48: The Ins And Outs Of Roth Conversions
Welcome to episode 48 of the fiscal blueprint podcast! Today we are going to talk about the Ins and outs of Roth conversions and answer a few questions such as: What is the purpose of a Roth conversion? How does it benefit you? And what are the pros and cons of completing a Roth conversion?
Disclaimer: Please do not take advice from me on this show. As a licensed Fiduciary I am only allowed to give advice to clients. So, unless you are a client, I cannot give you advice because I don’t know you. So, think of this as helpful hints and education only. And please before implementing any information or ideas you hear on this show always consult your legal adviser, your tax adviser, and your financial advisor.
Today we are talking about Roth conversions and ins and outs of this especially important strategy!
We are approaching that time of year, tax time! And many people that exercised Roth conversions last year may not realize that there are taxes due on that strategy so before folks rush out an implement a Roth conversion this year, we are going to talk about how to properly conduct a Roth conversion and the long-term goal of the strategy.
One of the biggest things that Joani wants to address is that Roth Conversions can only be done within the year. I.e., if you wanted to make a conversion in 2020, you could only do so between Jan 1st and Dec 31st; it’s not like contributions where you have until April 15th of the following year.
(1:56) Conversion vs contribution- If you had earned income last year, and you still want to make a contribution for the 2020 tax year, you can do that! You have until April 15th. However, a conversion, would have had to complete that by 12/31/2020.
So, let’s just start with the basics: and talk about the differences between a Traditional IRA and a Roth IRA; and then get into the mechanics of completing a Roth conversion.
(3:12) You must have earned income in order to contribute to a traditional IRA. There are limits to what you can contribute, typically its $6,000, unless you are over 50 in which case you can contribute up to $7,000. It is important to note that these contributions are PRE-TAX!
Remember, anyone can make a contribution no matter what your income is, what your age is, where you work, you just have to have earned income! There are some nuances on whether you get a tax deduction for these contributions so make sure you check into that.
A Roth contribution is never tax deductible. However, when you go to take out money from your Roth, so long as you’ve followed all the rules, that money will be tax free, even the interest and earnings.
(5:00) Many people talk about a Roth Conversion: where you convert money from a traditional IRA into a Roth IRA. The conversion will be taxable, so why do that?
Well, the answer is, if you think taxes are going to go up in the future, wouldn’t you rather pay them now while the rates are lower?
Right now, we are in the lowest tax environment since the inception of the tax code. The top marginal tax bracket right now is 37%. So, there is certainly room for it to increase.
And what happens with a traditional IRA at age 72? You are required to take money out, regardless. (RMD’s)
The IRS looks at your IRA as income! That’s why they make you take these RMD’s, it’s time to pay the piper!
The idea here is if we think tax rates are going to increase in the future, then converting now and paying taxes now while they are lower could make sense because you could be paying more money in the future. PLUS, the Roth IRA is also going to grow tax free AND the government is never going to force you to take money out because they are not getting any tax ‘income’ from your Roth.
(9:00) Now, regarding the mechanics of actually completing a Roth conversion. It is rather simple.
And for the purpose of this podcast, we are going to talk about Direct Transfer’s from. One account to the other. Now, technically you could do the same thing with a 60-day rollover where you receive the funds and then you have 60 days to put those back into a Roth IRA account or back into your traditional IRA account. And you can complete one of those per year, according to IRS guidelines. There is no limitation on the number of direct transfers you can complete on a per year basis because it is technically not a 60-day rollover.
So, the simplest way to do it is to contact the custodian or your financial advisor to complete the process. You would simply request a transfer from your Traditional IRA to your Roth IRA in the amount that you choose to convert.
(11:50) What are some things to watch out for?
#1 Taxes- Just remember to have money saved away for taxes, because you will receive a 1099 for the amount you took out of your IRA, and you will be on the hook for taxes due on that amount.
#2 If you are of RMD age (over 72) You must take your RMD prior to converting funds from your traditional IRA to your Roth IRA.
#3 NOTE: if you make too much money, you cannot CONTRIBUTE to a Roth IRA. HOWEVER, there is no income restriction for CONVERSIONS.
*ALWAYS check with your accountant and financial advisor when considering conversions or contributions. Make sure you are fully aware of the tax consequences! *
(14:15) Some disadvantages:
#1- Medicare high income surcharge- In 2021, the standard premium for Medicare Part B, which covers doctor visits and outpatient services, is $148.50. But if a Roth conversion increases your modified adjusted gross income above a certain amount, you could pay much more than that.
PS your Medicare part B payments are based on ax returns from 2 years prior!
#2- Social Security Benefits- The additional income from a Roth conversion could increase the portion of Social Security benefits that are subject to federal income taxes.
#3- Taxes on investment income/ capital gains taxes- because a Roth conversion will increase your taxable income, taxes on your investment income could go up, too.
Our tax code is full of these little ‘gotchas!’
(20:00) some other items:
~If you think that long-term, tax rates are going to increase by even 1%, then it may make sense to do a conversion.
~After the Secure Act was passed last year, the new rule is that if you leave a traditional IRA to a non-spouse beneficiary, the stretch IRA was eliminated. So, the more you leave to a Roth IRA, the better because taxes are not a factor!
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