Roth IRA conversions have always been a valuable tool in tax and estate planning, allowing the individual to pay taxes now and receive tax-free growth and income in the future. The primary factor in determining if converting is worth the cost is the amount of taxes owed now versus the amount of taxes that will be owed in the future. It’s not enough to only think of the current owner’s tax bracket. The tax bracket of the beneficiary must also be considered. If the original owner doesn’t empty the account while alive, taxes will be owed at the beneficiary’s marginal tax rate. There’s a good chance the beneficiary will inherit the account during his or her prime earning years, making taxes that much more of a drain.
Unless you’ve been totally disconnected from what’s been going on in Washington, you know major changes to tax and estate planning have occurred or are right around the corner. Passed as part of the SECURE Act in 2019, the IRA 10-year rule, AKA the ‘Death of the Stretch’, is one of those laws with profound consequences, and not in a good way. This law requires inherited retirement accounts be emptied within ten years for most beneficiaries, eliminating future tax advantaged growth over the beneficiary’s lifetime. Distributions from traditional retirement accounts are taxed at the highest tax rate of the beneficiary.
If that wasn’t enough, the current administration has plans to raise taxes. At the moment, only the wealthy are targets of these new tax increases. However, what most people don’t realize is that the current tax brackets are set to expire at the end of 2025. They will revert back to pre Tax Cuts and Jobs Act rates, which means all but a few tax-payers will see an increase in their taxes owed. A future increase in tax rates makes Roth conversions more appealing.
To compound these issues even further is the skyrocketing spending plans of our government. Currently, the infrastructure bill will add trillions of dollars to our national debt. In the latest versions, no clear plans on how to pay for this spending have been included. Add in the following and we have the making of a true national fiscal crisis:
2024: Medicare Part A can only pay 83% of expenses
2026: Pension Benefit Guaranty Corp likely to be insolvent
2031-34: Social Security only able to pay 79% of benefits
With these projected spending increases and major social program funding shortfalls, taxes are highly likely to increase sooner rather than later. And not just for the wealthy. The high likelihood of increased tax rates makes Roth conversions now even more advantageous.
It’s no wonder tax and estate planners are beating the drum trying to make people aware of the consequences of doing nothing. Once tax rates increase, it will be too late. Uncle Sam will get a larger chunk of your retirement account and your beneficiaries will be left with less.
There are many good reasons converting your retirement account to a Roth may make sense. However, there are situations where converting may not be a good idea. Each of us has unique circumstances that will dictate the correct choice. To get into all the factors involved is beyond the scope of this article. If you would like to know if a Roth conversion is a good fit for you, contact me and I would be happy to analyze your unique situation.
We will discuss the advantages and disadvantages of your options, and then you can decide if taking action is best for you. If you decide to make a conversion, I can help with that, too.
Nick Naseman is a Retirement Income Certified Professional® and President of Iron Mountain Financial, an independent Registered Investment Advisory firm. He guides retirees and near retirees through the planning process to empower them to take control of their retirement by designing and implementing retirement income strategies for those seeking more from their assets without running out of money and not taking on additional risk. Nick can be reached at 719-623-7433 or Nick@Iron-Mountain-Financial.com.