"Roth IRA" sign with piggy bank and calculator

Roth conversions should be considered for many individuals over age 70.5 in 2020, especially since required minimum distributions (RMDs) have been waived. If income is down, the tax impact of a conversion is also lessened.

See below for additional reasons to look at a Roth conversion or contribution.

  1. Tax-free accumulation of wealth. Once contributed or converted to a Roth IRA, there are no taxes paid on the money. No tax on capital gains, no tax on dividend or interest income, no income tax on distributions.
  2. Tax-free income in retirement. There is no income tax on distributions, unlike regular IRAs or 401(k).
  3. Protection from future income tax rate increases. Tax rates are unpredictable and are likely to change in the future. What if taxes go up in the future? Locking in today’s tax rate may turn out to be a great strategy.
  4. Protection from Medicare surtax. Distributions from a Roth IRA are not subject to the Medicare surtax and not included in the calculation for the income threshold used to determine if the surtax applies. However, RMDs from traditional IRAs or 401(k)s are included in the threshold calculation. This may result in income over the threshold and consequently subject to the surtax.
  5. No age requirements. RMDs are not required and contributions can continue as long as there is earned income. For someone who is in their 80s and earning income (including business income), contributions can still be made to a Roth IRA.
  6. Withdraw contributions at any time. If circumstances change, withdrawals in the amount that has been contributed can be made without any tax or penalty. Note since gains have not had any taxes paid on them, the withdrawal rules are different.
  7. Access to Roth IRA gains before age 59.5 without penalty in certain situations.Gains are accessible if used for the purchase of the individual’s first home (up to $10,000 per person). Rules for this are:
    • Prior to age 59.5 gains can be withdrawn without a penalty, but with taxes, if the Roth was open less than five years.
    • If more than five years, no taxes or penalty.

Other circumstances for this type of withdrawal include qualified education expenses, permanent disability, payment of health insurance premiums while unemployed, and unreimbursed medical expenses in excess of 10% of adjusted gross income (AGI). The CARES Act has waived the 10% penalty for coronavirus-related distributions in 2020, and it gives three years to return the money to avoid income tax.

  1. When the market is down, market recovery may be “leveraged” in a tax-free Roth.Contributing or converting to a Roth in a market downturn is like “buying low” into the market. Future growth and distributions are tax-free, which could add 10% or more to an eventual realized return (depending on tax bracket). There are several caveats here:
    • Consider making this move when there is a market pullback of 5% or more rather than trying to find the “market bottom.”
    • Roth IRAs are best used for long-term money to maximize the benefit of tax-free growth.
    • Review your individual tax situation. A conversion to a Roth requires an income tax payment on the converted amount.
  1. Fund college expenses for you, your spouse, children or grandchildren.A Roth IRA can be used to help fund college expenses under the same rules as above in item 7. If under age 59.5, contributions to the account can be taken out while leaving the gain in the account to continue growing tax free. Additionally, Roth IRAs have no impact on initial eligibility for financial aid (although the income to the child may impact their financial aid for the next year). This method of college funding allows saving for retirement as a first priority and maintaining a tax-advantaged option for paying for college later. Generally, a 529 Plan would be the preferred college savings vehicle when planning ahead for these expenses.
  2. Tax-advantaged asset for estate planning. Leaving a Roth IRA to your children or grandchildren gives them an income tax-free inheritance. This is a huge benefit to children who are themselves in a high tax bracket. Heirs could take a lump sum tax free; but if they invested the proceeds, everything would be taxable going forward. Instead, they could wait to take their required distribution until the end of the 10-year distribution period—leaving more money in the account to continue growing tax free.

If you have questions about Roth conversion or contribution, feel free to contact James Moore’s wealth management CPAs. We work hand in hand with HK Financial Services to provide the experience you need to manage your investments and other funds.

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