Finances in Retirement - Investments, Tax Planning Ideas and Tax Updates

When Should You Perform a Roth IRA Conversion?

by Alli Thomas

Sep 20, 2021

We often talk about Roth IRAs – and for good reason, as they are a great tool for tax-free earnings growth. 

Roth IRAs are primarily touted as savings vehicles for lower-income workers with a long investment horizon that expect to be in a higher tax bracket in retirement. However, since assets in a Roth IRA are not subject to probate and can be passed on to heirs tax-free, wealthier investors may also benefit. 

The Roth IRA didn’t exist before 1998, so if you’re already retired, chances are good that you may not even have one. But that doesn’t mean you can’t take advantage of the unique features of this kind of IRA. A backdoor conversion allows investors with traditional pretax IRAs to convert those funds to a Roth. 

Three Key Factors to Consider  

If you’re thinking of doing a Roth IRA conversion, here are a few things to consider: 

Your future tax rates. 

If you think your tax rate will rise in the future, it may be worth it to convert your traditional IRA to a Roth IRA and pay those taxes upfront now. 

When you’ll need to access these funds. 

If you expect to live off your traditional IRA savings in the near term, then you may want to hold off on that Roth conversion. 

Your beneficiary’s future tax rates, if applicable. 

This is a bigger consideration for older retirees, but if the person you have named as your beneficiary for your IRA expects to be in a higher tax bracket in the future, you may want to consider converting your traditional IRA to a Roth IRA now. This way, the assets will be inherited tax-free. 

Just keep in mind that you’ll have to foot the tax bill, so this is something that you’ll want to carefully consider before making any decisions. And if your beneficiary expects to be a in a lower tax bracket at the time of inheritance, then it may make more sense not to convert your traditional IRA instead. 

In any event, the IRS requires those who are subject to RMD rules (individuals 72 or older) to first take the RMD before any amount of your traditional IRA can be converted to a Roth IRA. 

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Why You Should Perform a Roth IRA Conversion Sooner Than Later 

Even if you don’t think your income will increase enough to put you into a higher tax bracket, you should consider performing a conversion sooner than later. 

Many financial experts believe that the Tax Cuts and Jobs Act of 2017 (TCJA) reduced federal income tax rates to the lowest level they may ever be. Here are the rates for 2021:

Rate  Single  Married Filing Jointly   Head of Household 
10%  Up to $9,950  Up to $19,900  Up to $14,200 
12%  $9,951 to $40,525  $19,901 to $81,050  $14,201 to $54,200 
 22%  $40,526 to $86,375  $81,051 to $172,750  $54,201 to $86,350 
 24%  $86,376 to $164,925  $172,751 to $329,850  $86,351 to $164,900 
 32%  $164,926 to $209,425  $329,851 to $418,850  $164,901 to $209,400 
 35%  $209,426 to $523,600  $418,851 to $628,300  $209,401 to $523,600 
 37%  $523,601 or more  $628,301 or more  $523,601 or more 

 TCJA includes a sunset provision and tax rates are scheduled to return to their pre-2018 amounts in 2026. But it’s possible that these tax rates will not make it that far. 

If you’ve been thinking about doing a full or partial Roth IRA conversion, now is the time to take action. The year is almost over. That means you probably have a pretty good idea of what your total annual income will be. This should help give you a clearer picture of how much of a conversion you can afford to do without crossing into a higher tax bracket.


Other Ways TCJA Made Roth Conversions More Attractive 

Let’s say that you were in the 33% marginal tax bracket before TCJA was passed. But since 2018, you’ve shifted to the 24% tax bracket. If you were to do a Roth conversion this year, you’d pay less in federal income taxes on the amount you convert than you would have before TCJA. 

That may sound great. But what if you’re trying to avoid taking a huge tax hit in a single year? No problem! Assuming the lower tax rates remain until 2026 as planned, you may choose to convert smaller amount of your traditional IRA to a Roth IRA every year through 2025. 

Here’s another example. Let’s say you’re single and will earn about $125,000 this year. This would put you in the 24% tax bracket. 

Now let’s say you have $75,000 in a 401(k) plan with a former employer. If you converted all of it to a Roth IRA this year, you’d be taxed at the next higher marginal rate (32%) on nearly half of the conversion amount. 

Instead, you could do several smaller partial conversions and spread them over several tax years. If your income remains about the same each year, your Roth conversions would be taxed at the 24% marginal rate. 

Another benefit of TCJA is that the width of some joint-return tax brackets have been doubled to twice the size of the single filer bracket. Taxpayers in these brackets can now do Roth conversions on larger amounts without having to worry about being pushed into a higher tax bracket. If you’re married and in the 22% or 24% marginal brackets, you should seriously consider doing a Roth conversion before 2026. 

There is one downside that TCJA brought for Roth conversions. Before 2018, Roth conversions could be reversed via a recharacterization. That’s no longer the case. If you’re wondering why anyone would want to do that, here’s the reason: if your account took a hit from a market decline, reversing your Roth conversion could help you avoid paying tax on money that was no longer there. But TCJA took this reversal option off the table. 


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Why 2021 Might Be the Right Time for You

Besides tax rates, how do you know if 2021 is the best time for you to perform a Roth IRA conversion? Here are three scenarios: 


Your 2021 earnings will be lower than usual.  

If you’re still working and will fall into a lower tax bracket than normal, you may want to consider a Roth IRA conversion at your current lower tax rate. 

This scenario is most feasible for workers who have variable income from year to year, such as commissions or bonuses. 

You’re retired but haven’t started taking Social Security benefits 

You may find yourself in a lower-than-usual tax bracket in the year that you retire. Your earnings may be lower than normal during your retirement year, especially if you retire well before year end. Your income will be further reduced if you choose to put off taking Social Security. And, if you delay taking it for a few years after you retire, you may have a considerable window of opportunity to do a series of Roth conversions while you remain in a low tax bracket.   

When you do start taking Social Security benefits, your income will rise. If you have a traditional IRA or 401(k), you’ll also see an increase in your income once you turn 72 and start taking required minimum distributions (RMDs) from those accounts.  

The benefit of doing a Roth IRA conversion during the window between retiring and drawing your Social Security benefit (which you must start doing by age 70) is that Roth IRAs aren’t subject to RMDs.  

One thing to remember is that RMDs may not be rolled over into a Roth IRA, and they must be distributed before doing a Roth IRA conversion once you reach age 72. 

You want to make charitable donations

If you’re looking to donate appreciated assets, the tax deduction you get from it may be used to offset the tax you’ll owe on a Roth IRA conversion. However, you must be able to take an itemized deduction for your donation.  

The CARES Act, which was passed in 2020, gave you the ability to deduct charitable contributions up to 100% of your adjusted gross income, and this has been extended to this year, too. Since the bull market in stocks continues to rage on, it may be worth considering donating appreciated assets this year. This would allow you to offset the tax cost of a Roth conversion in 2021. 


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Alli Thomas

Alli Thomas has worked in the financial services industry for nearly 20 years, with a focus on retirement-related investing. She began her career as a FINRA-licensed participant-services call-center associate at Vanguard, and then moved to Principal Financial Group, where she worked closely with employers, assisting with retirement plan set-up and design, selecting appropriate plan investment offerings, and maximizing employee participation through targeted education campaigns and enrollment meetings. Alli has also worked as a qualified 401(k) administrator and registered investment advisor for several small investment firms. She now writes about all things investment- and finance-related, leveraging her extensive experience and passion for retirement planning to help investors make well-informed financial decisions.

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