When to Accelerate Income with a Partial Roth IRA Conversion

Clete Albitz, CFA, CFP®

Clete When To Accelerate Income With A Partial Roth Ira Conversion

The U.S. government has unleashed unprecedented fiscal and monetary stimulus as a response to the current economic situation.  At some point, we will likely be paying this bill in the form of inflation or higher taxes.  If you expect your marginal tax rate may increase in the future due to a general tax increase or personal circumstances, you may want to consider a partial Roth IRA conversion.

The main advantage of a Roth IRA, unlike a traditional IRA, is that you do not have to pay income tax on the money you withdraw in retirement.  Roth IRAs are not subject to required minimum distributions at age 72 meaning the funds can compound tax-free during your lifetime.  Although there are income limits to fund a Roth IRA directly, there are no limits to converting traditional IRA funds to a Roth IRA.  In fact, even if you earn above the income threshold to fund a Roth IRA directly, you can still fund a traditional IRA and convert it to a Roth IRA.  This is often called a “backdoor Roth IRA.”

If you have an IRA and your tax bracket is expected to be higher in the future due to starting Social Security, taking required minimum distributions, or a higher expected level of income from another source, you may want to consider a partial Roth IRA conversion.  By converting a certain amount of money from your IRA, you decide to pay the taxes now (it is best pay taxes from outside your IRA) and the funds are transferred from your IRA to your Roth IRA.  Accelerating your income will be beneficial if the income taxes incurred are taxed at a lower marginal rate than you will face in later years.  Furthermore, by converting funds from your IRA, you reduce the level of your future required minimum distributions, potentially keeping you in a lower marginal tax bracket indefinitely.

Partial Roth IRA conversions can result in a substantial tax savings over time.  The specifics can be complicated based on your unique situation.  Future account returns, income levels, and tax rates will all affect how beneficial a Roth conversion may be for you.  In some cases, Roth IRA conversion can have unintended consequences such as increasing the amount of tax owed on Social Security income.  Make sure you review carefully before moving forward.  Nevertheless, we have found it often beneficial if you can accelerate income at the lower end of the marginal rate spectrum (24% and less).  This tax diversification can provide you with important flexibility in developing a tax efficient retirement income distribution strategy considering the likelihood of higher future tax rates.

For a comprehensive review of your personal situation, always consult with your legal or tax advisor. Neither Cetera Advisor Networks LLC nor any of its representatives may give legal or tax advice. A Roth IRA offers tax free withdrawals on taxable contributions. To qualify for the tax-free and penalty-free withdrawal of earnings, a Roth IRA must be in place for at least five tax years, and the distribution must take place after age 59½ or due to death, disability, or a first time home purchase (up to a $10,000 lifetime maximum). Depending on state law, Roth IRA distributions may be subject to state taxes.

Clete Albitz

CFA, CFP®

Clete Albitz joined Albitz/Miloe & Associates, Inc. in 2005 and is dedicated to serving clients, specializing in investment portfolio management and retirement income planning. Clete is a CFA® charterholder, CERTIFIED FINANCIAL PLANNER™ (CFP®), and graduated with a degree in Economics from the University of California, San Diego. He enjoys playing baseball, basketball, and coaching Little League. Clete resides in the South Bay with his wife and three children.

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