Roth IRAs are generally considered among the most attractive retirement savings vehicles available to individual investors. They offer the unique potential to grow investment earnings without incurring any income tax liability, if qualifying distributions are made.

It’s important to note that how much you can contribute to a Roth IRA depends on your tax filing status and modified adjusted gross income (MAGI). For a single filer in 2020, your income must be under $139,000 (or $206,000 if you’re filing jointly) in order to contribute.

Beyond making regular contributions to a Roth IRA, the other way to take advantage of this savings tool is to move money from a traditional IRA or workplace savings plan to a Roth IRA. These are referred to as Roth IRA conversions. Now may be an opportune time to give this idea a closer look. Here’s what you should know:

A taxable transaction

The key factor affecting the decision to pursue a Roth IRA conversion is the tax impact. Remember that some or all of the distributions from traditional IRAs are taxed at ordinary income tax rates. If contributions were made on a pre-tax (tax-deductible) basis, the entire amount of the withdrawal is subject to tax. If after-tax contributions funded a traditional IRA, only the portion of the distribution attributable to investment earnings is taxable.

With a Roth IRA, all contributions occur on an after-tax basis. If holding period requirements are met, all distributions can be received on a tax-free basis.

Moving money from a traditional IRA to a Roth IRA is a taxable event at the time of the conversion. Consider an example of converting a portion of a traditional IRA to a Roth IRA. If all contributions to the traditional IRA were made on a pre-tax basis, the entire value of the converted amount is added to your ordinary income for the year and subject to tax at applicable rates.

Make tax-smart conversion decisions

If we assume this conversion totaled $100,000 and an ordinary income tax rate of 24% applies to the converted amount, that results in a tax liability of approximately $24,000. It is often recommended that you pay the tax due from available resources in existing taxable accounts. This allows the entire amount converted to be shifted to the Roth IRA, maximizing the long-term tax benefits of the conversion.

You don’t have to convert all of your IRA assets at one time. It can occur over a series of years to spread out the tax impact. Remember that income is taxed on a progressive scale across a range of tax brackets. You may want to convert an amount that will stay within your current tax bracket. For example, a married couple expecting to have a taxable income of $100,000 for 2020 will be in the 22% federal income tax bracket. That bracket for married filing jointly continues to apply to taxable income up to $171,050. Therefore, they could convert an additional $71,050 without any of the converted amount slipping into a higher tax bracket.

The timing may be right

Another consideration relates to the future of tax rates in America. Current income tax rates are near their lowest levels in recent history. There is concern that due to skyrocketing federal debt (much of it spurred on by recent stimulus legislation related to the COVID-19 pandemic), tax rates may rise in the future. By taking the tax hit at this time when you convert funds to a Roth IRA, you may ultimately pay less in tax on your IRA than if you waited to take distributions later, assuming tax rates are higher.

Roth conversions can be a very effective tool both in terms of tax management and in helping generate greater after-tax cash flow in retirement. But the process can be complex. Be sure to consult with your financial advisor and tax advisor for more guidance.


Andrew R. Petty, CRPC®, APMA®, CLTC®, is a Private Wealth Advisor with Nona Wealth Advisors, a private wealth advisory practice of Ameriprise Financial Services, Inc. He offers fee-based financial planning and asset management strategies and has been in practice for 19 years. To contact him, please call 407-249-4006, visit his website at or stopover at his office at 10917 Dylan Loren Circle, Suite A, Orlando, FL 32825.

Ameriprise Financial, Inc. and its affiliates do not offer tax or legal advice. Consumers should consult with their tax advisor or attorney regarding their specific situation.

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