The recent market downturn has created an opportunity for some to convert part or all of a traditional, pre-tax retirement account (such as a 401(k) or IRA) to an after-tax Roth account. The goal of this strategy is to take advantage of lower account values to pay taxes now and avoid a potentially higher tax bill in the future
Roth IRA Tax Overview
Traditional IRA or 401(k) assets go into the account with a tax deduction, grow tax deferred, and when withdrawn are taxed as ordinary income. Roth assets, however, don’t get an upfront tax benefit when contributed, but grow tax-free, and are withdrawn tax-free in the future. With the tax rates of the Tax Cuts and Jobs Act set to expire in 2026 and revert to their higher 2017 levels, some clients now see the depressed prices of the stock market as an additional advantage to converting traditional IRA assets to Roth.
Additional Benefits of Roth IRA
Roth funds also have a few other benefits. Unlike traditional IRA accounts, investors don’t have to start required minimum distributions at age 72. Also, replacing traditional IRA distributions with Roth distributions could decrease Social Security taxes and Medicare premiums. Lastly, under the SECURE Act, beneficiaries of IRA and Roth IRA accounts have only 10 years to distribute funds inside the inherited account. Inherited Roth account owners wouldn’t have to pay tax on any of the distributions made within the mandatory 10-year distribution window.
Other Considerations
While lower account values do make Roth conversions more attractive for some, there are many other factors that need to be considered, such as current and future tax brackets, other portfolio holdings, cash availability, charitable strategies, and estate plans. Please contact us if you have questions about how this strategy may fit into your financial picture.
