Tax Update Graphic_05-2022

By Kristin Carter, CPA – Vice President & Tax Officer

Given the recent volatility in the stock market, now might be a good time to consider a taxable Roth conversion from pre-tax retirement funds, such as 401(k) and traditional IRA accounts. Lower values in retirement accounts means paying less in taxes on the conversion than when values are soaring in a market uptick, making the tax bite easier to stomach.

Converting pre-tax retirement funds into a Roth IRA triggers tax to be paid on the value of the conversion at ordinary income tax rates, up to 37%. Because tax has already been paid on Roth dollars, the Roth account continues to grow tax-free over time and funds can be distributed without incurring additional tax (subject to a few rules). Diversifying your retirement portfolio between pre-tax and post-tax accounts, such as traditional and Roth IRAs, provides a nice opportunity to balance the tax burden during retirement.

There are a few important things to keep in mind when contemplating a Roth conversion:

  • There are no income limits on conversions, so someone who makes too much income to contribute to a Roth IRA under the normal Roth contribution rules can convert pre-tax 401(k) or traditional IRA funds instead.
  • Unlike traditional IRAs, Roth IRAs have no annual Required Minimum Distribution (RMD) requirements. Someone with a traditional IRA that does not want or need to take RMDs might be better off parking their money in a Roth IRA and letting it grow tax-free over time.
  • Before making the decision to convert pre-tax funds to a Roth IRA, careful consideration should be given to the account owner’s age, heirs’ tax brackets, and the owner’s own cash needs.
  • Remember, you don’t have to cash out the investments in your retirement account in order to make the conversion; you can transfer investments “in-kind” and let them rebound tax-free in the Roth IRA account. This is a powerful strategy for investments that you’d like to hold onto for the long-term. Alternatively, it is a good time to diversity your retirement portfolio by shedding unwanted investments and converting cash to a Roth IRA.
  • A word of caution: Triggering a Roth conversion would increase your tax return Adjusted Gross Income, which could impact Medicare premiums, overall tax rates, and other items tied to income thresholds.

Including a “traditional versus Roth” analysis as part of a more holistic financial plan is time well spent. Your team at Central Trust Company is well versed in helping clients plan for retirement and looking for opportunities such as this. Reach out to your advisor to learn more, and determine if a Roth conversion might be beneficial for you.