Historically low tax rates make now an ideal time to convert traditional individual retirement accounts into Roth accounts. Financial planners and tax advisors are advising their clients to switch soon, to take advantage of the Tax Cuts and Jobs Act.
"It's the best time in history to convert to a Roth," says Elijah Kovar, co-founder of Great Waters Financial in Minneapolis. "Between now and 2025, the last year of tax reform, taxes are on sale."
With a traditional IRA, you don't pay taxes on the money you deposit, but withdrawals are taxed as ordinary income. With a Roth, you deposit money on which you've already paid taxes, so the money you withdraw in retirement is not taxable. The reason to convert now is so you don't get hit with higher taxes when you take distributions in retirement.
Avoid a big retirement tax bill with a Roth IRA
A Roth IRA conversion means you pay tax on your savings in the year you move your money from the traditional retirement account to the Roth in order to set up tax-free income later in life. Your Roth distributions will eventually be a tax-free source of retirement income. Roth account withdrawals also won't contribute to your Social Security income becoming taxable. "Pay those taxes now and get it tax-free (in retirement), so when you retire at a much higher tax bracket, the taxes are paid," says Joe Wirbick, president of Sequinox in Lancaster, Pennsylvania. "Take advantage of low tax brackets with a Roth and never pay taxes on that money again."
Some people use a traditional IRA because they expect to be in a lower tax bracket in retirement than they are now. However, if you save a large nest egg, you could face a higher tax rate in retirement. "The biggest myth is if you put money in a traditional IRA or 401(k) and defer taxes, when you retire you are in a lower tax bracket," Kovar says. “That is not true for anybody who has saved a significant amount of money.” Between Social Security income, pension payments and required minimum distributions from 401(k)s and IRAs, some people end up in a higher tax bracket in retirement. "The myth of lower taxes later is not true, not for savers," Kovar says.
The latest tax cut means many people are currently paying a lower tax rate than they did even a few years ago. "We know they are going back up in 2026," Wirbick says. "Why would you not take advantage of a significant reduction in taxes and get yourself out of a taxable future and into a tax-free future?"
Pitfalls of Roth IRA conversions
It's helpful to consult a financial professional before initiating a Roth IRA conversion. There are some pitfalls to converting a traditional retirement account to a Roth. For example, withdrawals from traditional IRAs, even in a Roth conversion, will increase your income for that tax year. If you boost your income past a tax bracket cutoff, you will increase your tax rate on the conversion. "To go from the 12 percent bracket to the 22 percent bracket is an 83 percent increase in taxes," Wirbick says. "Be careful. You don't want to convert so much that it pushes you into another tax bracket."
A Roth conversion could also have unintended results for your retirement benefits if you initiate the transaction after signing up for Social Security or Medicare. "It's possible that you could push taxable income up enough that it changes Medicare Part B premiums, which are based on income," says Ken Moraif, a senior advisor at Money Matters, a wealth management and investment firm in Dallas. "Also, you could have Social Security benefits get taxed at a higher rate. You need to be careful that you don’t cost yourself hundreds more in premiums and taxes that you were not ready for. It's not just as simple as paying tax on your IRAs." It's important to examine how a conversion will impact your other retirement benefits before moving your money. "It is complicated, and you need to make sure you are talking to a professional before you do it," Moraif says.
Consider gradually converting your retirement savings
You don't need to convert your entire IRA balance to a Roth account in a single year. "Don't be in a hurry," Wirbick says. "Don't do it all at once." You can gradually convert your retirement savings over a period of several years, which helps to avoid a big tax bill in a single year.
Consider doing a partial conversion that's enough to get you to the top of your current tax bracket without pushing you into a higher one. Even if you make a partial conversion, it will reduce your traditional IRA balance and your taxable required minimum distributions in retirement. "Get it done now," Wirbick says. "Taxes will go up eventually."
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