Federal tax rates went down with the Tax Cuts and Jobs Act of 2017, but those cuts are already set to expire in 2025. And there is broad support among Democrats for repealing tax cuts before their expiration.  Let’s face it. There is a strong likelihood that your tax rates will be going up.

Most of us instinctively avoid paying taxes sooner when we could pay later, but what matters most is the tax rate you pay, not when you pay it.  This is especially important to keep in mind as you plan for your future retirement.  Most retirees expect the bulk of their retirement income to come from conventional IRAs and 401(k)s.  Any withdrawals from these accounts are subject to income tax at ordinary income rates.

If you believe your tax rate is lower now than it will be in the future, this might be the opportune time to convert your IRA or 401 (k) to a Roth IRA.  Maybe your business has suffered because of Covid-related closures, you’ve had a layoff, reduction in hours or temporary disability.  Or perhaps you are a retiree in your “gap years.”  You are no longer working, or have otherwise reduced your earned income and not yet drawing Social Security or taking required minimum distributions from your IRAs.

Roth conversion is a valuable financial strategy, but it is important to know how to apply it to your financial situation.  Knowing your marginal tax rate is important so the conversion won’t bump you up into a higher tax bracket.  Working up a plan of successive yearly Roth conversions with your tax advisor can allow you to stay within a lower tax bracket by reducing required minimum distributions (RMDs) and allowing compounded investment returns in your Roth to accumulate tax-free.

Now may not be the time for everyone with a traditional IRA or 401(k) to consider a conversion.  Parents with children in college need to be aware that a Roth conversion will increase their reported income and may negatively affect their child’s financial aid profile.  You can make a Roth conversion at any age, even before age 59 ½, without having to pay the 10% penalty for early withdrawal as long as 100% of the money withdrawn from the traditional IRA goes into the Roth IRA. However, to encourage long-term saving, IRS rules require you to keep your money in a Roth for at least five years, or face that 10% penalty.

To learn more about how Roth conversions might be a valuable tool for your retirement planning, please contact one of our tax advisors. We are always happy to help!