Seizing the Moment: The Benefits of End-of-the-Year Roth Conversions
As November unfolds, it’s an opportune time to consider year-end financial strategies that positively impact your tax outlook and build your retirement savings. One tactic to consider is a Roth IRA conversion.
A Roth conversion involves transferring funds from an existing traditional, SEP, or SIMPLE IRA, or another qualified retirement plan, into a Roth IRA. This strategy can offer long-term tax advantages. However, a Roth conversion elevates your taxable income for the year the conversion happens.
Before exploring the advantages of year-end Roth conversions, let’s look at the general pros and cons of conversions:
Pros of Roth Conversions
Tax-free withdrawals: Roth IRAs allow tax-free withdrawals in retirement, a significant benefit if you anticipate being in a higher tax bracket later.
No required minimum distributions (RMDs): Unlike traditional IRAs, Roth IRAs are not subject to RMDs, which can help you gain greater control over your finances.
Tax diversification: Converting some of your assets to a Roth IRA can help boost tax diversification, providing more flexibility in managing your taxes in retirement.
Cons of Roth Conversions
Upfront tax liability: The conversion adds to your taxable income, potentially putting you in a higher tax bracket.
Potential tax policy changes: Future tax laws could affect the benefits of Roth conversions.
Advantages of Year-End Conversions
Potential benefits of completing Roth conversions as the year winds down include:
Initiating the five-year rule: One benefit is the retroactive start of the five-year rule. This rule requires a five-year hiatus before withdrawing converted balances without a 10% penalty. Even if you complete a conversion in December this year, the five-year rule will backdate to January 1.
Better income assessment: With the year’s progression, you gain a more precise understanding of your annual income. This clarity is key since the amount you convert will augment your taxable income. A smart move may be to convert an amount that tops your income at the highest limit of your current tax bracket without going over it.
Reduced income uncertainty: By the time you’ve reached year-end, the uncertainties surrounding your income and deductions are significantly reduced. This clearer picture can help gauge the tax impact of a Roth conversion, making it easier to decide on the amount.
Meeting the deadline: The deadline for a Roth conversion is December 31 of the current year. Meeting this deadline ensures the conversion amount is included in the year’s taxable income.
With the year-end in sight, keep in mind that current lower tax rates are set to rise post-2025 due to the scheduled sunsetting of the Tax Cuts and Jobs Act of 2017. You might consider the strategic timing of Roth conversions before then to help lock in tax savings.
Also, consider working with a fiduciary financial advisor. Roth conversions can be complex and the tax implications significant. Fiduciary, fee-only financial advisors can provide a personalized analysis based on your financial circumstances and best interests. They can help you decide if a Roth conversion is suitable and when it would be most beneficial.
Schedule a complimentary, 15-minute chat with a fee-only, fiduciary financial advisor today to discuss your personal situation.
This material was written in collaboration with artificial intelligence (ChatGPT) derived from sources believed to be accurate. This information should not be construed as investment, tax, or legal advice.
Parkshore Wealth Management is a family-owned, independent, fee-only Registered Investment Advisor with offices in Granite Bay and Folsom, CA, and Lehi and Logan, UT. We partner with financially responsible individuals and families who are eager to take positive steps that will allow them to use their money to build the life they desire. The firm is led by Harold Anderson, CFP®, and Daniel Andersen, CFP®, both members of NAPFA, the country’s leading professional association of fee-only financial advisors.