THIS STRATEGY OFFERS ANOTHER WAY FOR AFFLUENT INVESTORS TO PASS ALONG THEIR WEALTH
If you’ve saved diligently for retirement – or your parents have – and you’ve accumulated a sizable nest egg, recent rule changes affecting retirement distributions could seriously impact your financial strategy.
The Setting Every Community Up for Retirement Enhancement Act of 2019, more commonly called the SECURE Act, was signed into law in December 2019. It was sweeping legislation that included significant provisions to increase access to tax-advantaged accounts and prevent retirees from outliving their money, but it also eliminated a strategy many affluent investors have been relying on.
The “Stretch IRA” previously allowed non-spouse beneficiaries – most often children and grandchildren – to slowly take money out of an inherited IRA over their lifetimes. The SECURE Act eliminates this option, and now most non-spouse inherited IRAs must be drained of funds within ten years. This has the effect of much higher tax bills for non-spouse heirs. (Spouses can still treat an inherited IRA as their own and gradually take money out throughout their lifetimes.) Simultaneously, the SECURE Act delayed the age at which retirees must begin taking Required Minimum Distributions (RMDs) from their retirement accounts, changing it from 70 ½ to 72.
Taken together, these changes mean that big savers may benefit from a Roth conversion. If you have more than $1 million in your retirement accounts, read on to learn how this strategy may help you reduce future tax bills for yourself and for your heirs.
SEE ALSO: Your Retirement Tax Prep List
Roth Conversion 101: How it Works
A Roth conversion means transferring money from your traditional IRA or other retirement plans into a Roth IRA. These conversions usually trigger an income tax bill because you’re moving money from pre-tax accounts into a Roth, which consists of after-tax contributions. Once the transfer is complete, your Roth withdrawals will be tax-free, and there won’t be an RMD requiring you to take money out at a certain age either.
For big savers, a Roth conversion has the potential to provide a more tax-efficient savings strategy, while allowing more time for the account to grow and, thus, a larger nest egg to pass on. You may be wondering though, if it makes sense to convert and pay a large tax bill now, since it might be possible to access your money at a lower tax rate later – for example, if you find yourself in a lower tax bracket once you retire. It’s true that this is a barrier to Roth conversion for some people.
So, who does a Roth conversion make sense for?
Scenarios Where Roth Conversions are Smart Options
If you expect to be in the same – or higher – tax bracket when you retire, a Roth conversion can make sense right now. The best candidates for this strategy tend to be young, diligent savers who expect their incomes to continue climbing, or older workers or retirees who expect their tax bills to jump when they start taking Required Minimum Distributions (RMDs).
Roth conversions can also be a savvy move if your money is intended for heirs who will be in a tax bracket at least as high as your own. If your heir is likely to inherit your IRA in her peak earning years, for example, a conversion may be wise – especially now that she would have to withdraw the money in its entirety within ten years. (Conversely, you may not want to convert if, for example, your money is going to young grandchildren who will be in much lower tax brackets.)
An especially ideal time for a Roth conversion may be after you’ve retired, but before your RMDs begin. Many people see a dip in tax brackets during this period, plus a conversion can be spread out over several years to better manage the accompanying tax bill. Since the age for RMDs is higher now, there’s more time for many retirees to complete a Roth conversion, too.
What to Do Before You Convert
When a sizable nest egg is on the line, you should be careful about making any changes in your financial strategy. You should also pursue guidance from a financial professional in order to avoid unintended consequences which might be irreversible. For instance, a too-large conversion could push you into a higher tax bracket, cause additional taxes on your Social Security income or even increase your Medicare premiums. A financial professional can help you model how various conversion amounts could impact your future tax burden so you can see how a potential conversion would play out.
At TriCapital, we offer comprehensive wealth management and financial planning services. If you’d like to discuss whether a Roth conversion may be right for you, please contact us today to begin the conversation. We are pleased to offer our experience and knowledge in helping our clients achieve financial independence.
Securities offered through Triad Advisors, LLC, member FINRA/SPIC. Advisory services offered through TriCapital Wealth Management, Inc. TriCapital Wealth Management, Inc. is not affiliated with Triad Advisors, LLC.