Roth conversion benefits
Tax today will be financial cushion tomorrow
Recently, individual retirement account (IRA) expert Ed Slott (www.irahelp. com) pointed out the advantages of Roth conversions in light of President Joe Biden’s tax proposals. I’ll discuss some reasons you should consider such a conversion.
For high-income taxpayers, it is likely that marginal tax rates will not be reduced, and it is likely that marginal tax rates will increase in the future. The SECURE Act eliminated the stretch IRA for most non-spouse beneficiaries. These beneficiaries will be able to accumulate funds in a Roth IRA for 10 years on a tax-free basis.
Accordingly, if you do convert your traditional IRA to a Roth account, you will be providing a significant advantage to your future beneficiaries. Since it is likely that your tax rates will increase in the future, it would be to your advantage, as well as that of future beneficiaries, to do a Roth conversion in the near future rather than later.
An advantage in initiating a Roth conversion in the near future: It is less likely that any tax reform will be retroactive to Jan. 1, 2021. Any changes in the tax code will most likely be effective in 2022.
There are three tax benefits associated with a conversion in 2021.
1. By converting now, you are locking in today’s tax rates, which are much lower than previous tax rates.
2. A conversion now will lock in a 0% tax rate on the funds in the account for the rest of your life and your spouse’s life, and for 10 years for subsequent beneficiaries. Roth owners do not have minimum distribution requirements, and your surviving spouse also will not have any minimum distribution requirements. So, as long as there is no need to withdraw funds from these accounts, the accounts will continue to increase tax free.
3. Future taxes will be reduced because the funds converted will lower IRA balances subject to required minimum distributions, and accordingly will lower your taxes. It is true that, in the year of the conversion, there would be a tax increase. However, avoiding income taxes now is shortsighted and, in the long run, the advantages of converting now outweigh the disadvantages of paying an increased tax in the year of the conversion.
Currently, the estate and gift tax exemption is $11.7 million ($23.4 million for a married couple). However, it is possible that exemption can be reduced, which would have an adverse effect for large estates. The exemption could be reduced to as low as $3.5 million. Roth assets are included in your estate.
By converting now, that action would reduce the estate value because of the tax paid. The result would be a reduced estate tax and a larger net estate for your beneficiaries.
Paying the tax associated with a conversion now does not count as a gift for gift or estate tax purposes. The result would be that, even if the gift and estate tax exemption is lowered, the conversion is essentially a way to make a gift that isn’t categorized as a gift. Moreover, if you reside in a state that has lower estate tax limits than the federal regulations, there would be an additional advantage.
The bottom line is that there are many long-term advantages associated with a Roth conversion that outweigh the shortterm disadvantage of the additional tax.