Roth Conversion Strategies Provided by Skeels Cygan

Roth Conversion Strategies Provided by Skeels Cygan

In the world of retirement planning, one question that often arises is whether to convert a traditional IRA into a Roth IRA. This article aims to provide a clear and concise overview of the factors to consider when deciding if a Roth IRA conversion is prudent.

Firstly, it's essential to understand that income-related monthly adjustment (IRMAA) surcharges can apply to Medicare premiums for high-income earners, and Roth conversions can trigger higher IRMAA charges. Therefore, it's crucial to consider your current and future tax rates when making this decision. If you expect your tax rate to be higher in retirement, converting now to pay taxes at a lower rate makes sense. Conversely, if you anticipate being in a lower tax bracket later, converting may not be beneficial.

Another key factor is your ability to pay taxes on the conversion from outside funds. Using retirement funds to pay conversion taxes can significantly erode your account value, potentially incurring early withdrawal penalties if you're under 59½. Having non-retirement cash available is important.

Age and time horizon also play a significant role. Younger individuals have more time for tax-free growth to outweigh the upfront taxes. After age 60, you avoid early withdrawal penalties but still face the upfront tax liability and must wait five years before tax-free withdrawals.

If you have pre-tax money in other traditional IRAs, the taxable amount of the conversion is calculated based on the ratio of non-taxed to taxed funds across all IRAs, which can increase the conversion tax liability.

Expected need and timing of withdrawals are also crucial considerations. Roth IRAs avoid required minimum distributions (RMDs) at age 72+, providing more control over retirement income timing and potential tax optimization.

Strategies to minimize tax implications of Roth conversions include partial conversions during low-income or low-tax-rate years, market timing, spousal coordination, backdoor Roth conversions for high earners, and consulting a financial advisor.

Minimizing taxes can be achieved through strategies such as generous gifts to charities, bunching medical and dental expenses, and utilizing tax-loss harvesting in taxable accounts.

Roth IRAs do not have RMDs, making them an attractive option for retirees looking to avoid them. The authors of the article are doing large Roth conversions each year and have been able to keep their effective/average tax rate below 20%.

However, it's important to note that sophisticated retirement planning software is not widely available to individual investors for estimating the long-term tax savings of a Roth conversion. Moving money from a traditional IRA to a Roth IRA requires paying income taxes on the amount converted in the year of conversion.

The current tax rates in the U.S. are considered low, but the $36 trillion U.S. national debt may lead to higher tax rates in the future. Retirees can convert a traditional IRA to a Roth IRA at any age, but must take their RMD first each year.

Some tax preparers and financial advisors recommend doing Roth conversions that take a taxpayer to the top of their current marginal tax bracket. The "Big Beautiful Bill" passed on July 4 introduced new factors that impact Roth conversions, such as the tax deduction for SALT (state and local taxes), which phases out completely by $600,000 of modified adjusted gross income.

In conclusion, converting to a Roth IRA eliminates RMDs during retirement, may save significant taxes over the long term, and allows for tax-free inheritance. However, it involves paying income taxes now on the conversion. A strategy for people with large traditional IRAs is to convert a portion of the traditional IRA each year, with the goal of eventually having a Roth IRA earmarked for each of their children or grandchildren. Another strategy is to look for a year when your income may be low, and convert in that year.

This article is part of a three-part series on Roth conversions. The first article discussed 10 reasons not to do a Roth conversion, the second discussed the benefits, and this current article provides further details. It's always best to pay the taxes due on a Roth conversion from an after-tax account rather than from your traditional IRA.

1. When considering whether to convert a traditional IRA into a Roth IRA, one should take into account the potential impact of income-related monthly adjustment (IRMAA) surcharges on Medicare premiums for high-income earners.
2. The ability to pay taxes on the conversion from outside funds is crucial, as using retirement funds can significantly erode account value and potentially incur early withdrawal penalties.
3. Age and time horizon are significant factors, as younger individuals have more time for tax-free growth to outweigh upfront taxes, while retirees over 60 may face upfront tax liability but avoid early withdrawal penalties.
4. Strategies to minimize the tax implications of Roth conversions include partial conversions during low-income years, market timing, spousal coordination, and consulting a financial advisor.

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