In recent years, there has been a significant increase in the number of Roth individual retirement account conversions. Data from Fidelity Investments shows a 44% year-over-year growth during the first quarter of 2024. This type of conversion involves transferring pretax or nondeductible individual retirement account funds to a Roth IRA, which offers the benefit of future tax-free growth. Despite the allure of tax-free growth, experts caution that Roth conversions may not be the right move for everyone.
According to certified financial planner Marianela Collado, it is essential for investors to have “sufficient assets” outside of retirement accounts to cover the upfront tax bill associated with Roth conversions. Additionally, individuals must evaluate how the added income from the conversion might impact their eligibility for certain tax breaks. Higher earnings could also lead to income-related monthly adjustment amounts for Medicare Part B and Part D premiums down the line.
While the tax implications of Roth conversions depend on the amount converted and tax brackets for the year, these conversions can play a crucial role in reducing lifetime taxes or achieving legacy goals. CFP Ashton Lawrence suggests that strategic Roth conversions are particularly beneficial during stock market downturns, as investors can convert more shares and capitalize on tax-free growth during market recoveries. Conversions are also attractive in lower-income years, such as after a job loss or early in retirement.
With the elimination of the stretch IRA and the requirement for certain heirs to empty inherited IRAs within a 10-year period, Roth conversions have emerged as a popular choice for legacy planning. By converting pretax retirement balances into Roth accounts, investors can avoid substantial taxes during peak earning years. Additionally, Roth conversions offer tax diversification, the potential for lower required minimum distributions, and opportunities for inheritance planning.
Future Outlook and Considerations
Looking ahead, investors may want to take advantage of Roth conversions while tax brackets are relatively low. Changes in individual tax brackets are expected after 2025 following the expiration of provisions from the 2017 tax overhaul. The future of these tax breaks remains uncertain, especially with potential changes in control of the White House and Congress. Despite the complexities and considerations surrounding Roth conversions, careful planning and strategic decision-making can lead to significant tax savings and financial benefits in the long run.
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