When the market enters a downturn, it's a good time to evaluate whether you can benefit from the volatility to convert pre-tax retirement assets into Roth IRA account.
For many higher income earners, a Roth conversion is the only method
Since amounts to be converted can be transferred in actual shares of investments held, rather than just cash, investors can move over devalued assets and pay relatively less tax for the conversion than they would have possibly paid in 2014.permitted by the IRS to convert IRA assets into long-term, tax exempt status.
Anyone holding energy assets, for instance, who chooses not to sell them in face of current market headwinds, might consider whether moving these assets into a Roth account offers advantages both short term and long term. Some caveats apply for higher earner households, however.
The Medicare surcharge tax on investments, and on excess income, for instance, should be considered if the amounts transferred from IRA to Roth accounts push modified adjusted gross income over trigger thresholds. In 2015, these thresholds are $200,000 of modified adjusted gross income for people filing as single, and $250,000 for people filing as married.
The applicable IRS rules exclude income from muni bonds and muni bond funds from investment income calculations. Distributions from IRA or 401K accounts are included in modified adjusted gross income, not in investment income. For people earning wages, an additional employer payroll tax applies for amounts earned under $250,000 married, $200,000 single or head of household. Half the payroll tax, or 1.45% , is paid by the employee; half by the employer, under these thresholds.
If you choose to move assets including cash from a retirement plan to a Roth account, you would owe income tax on the amount you choose to transfer. This amount could boost you beyond the trigger threshold if you are not careful. Offsets to this increased income could include higher pre-tax contributions to retirement plans; and increased deductions for mortgage interest, state income taxes and local property taxes.
Since you are permitted to move actual shares rather than just cash into an IRA account, you could choose to move the shares of companies or securities that have suffered valuation loss in current market trading. In this way, you do not realize the loss; you just optimize it for the purposes of paying for the conversion at a lower tax rate.
The one aspect that often trips people up in conversions is the IRS requirement that you must aggregate all your IRAs to determine tax liability. You must consider all your IRAs and where those dollars came from. If you have another pre-tax traditional or rollover IRA out there and if you originally took a tax deduction on those dollars, this affects your tax liability on the Roth IRA.
For example, if you open a $5,000 nondeductible IRA and you also own a rollover IRA worth $95,000 from a previous 401(k) made with pretax contributions, then 95 percent of your contribution to the nondeductible IRA will be taxable when you do the Roth conversion.
While an experienced financial planner can help you determine the correct liability, the strategy works best for people who don't have other IRAs or who have rolled deductible IRAs into a 401(k) plan, eliminating the account from the tax consideration.
Another factor to consider is the length of time separating the actual conversion from the time you expect to take distributions. The longer you can wait, the more benefit you may realize from the conversion of assets. People nearer to retirement may be counseled not to do the conversion or to do a smaller conversion, if they will need income in less than 5-7 years.
Why consider a Roth IRA?
The answers vary depending on your situation. Here are some quick points to explore with your financial and tax professionals.
--Having a Roth IRA can allow you to lower your Social Security taxation. Distributions of capital after 5 years are not taxed; withdrawals of gains and income also escape taxation after this time.
--Extending your purchasing power and the longevity of your retirement accounts when you most need them; in your distribution years.
--Avoiding higher taxes later, if you expect to taxes to rise either due to adjustments in taxation rates or because of rising income from pensions and required distributions.
--Having more assets to support your income needs if you live long, as Roth IRA accounts are not subject to required minimum distributions applicable to other types of retirement accounts.
--Having the ability to pay the conversion tax now, or the tax in installment payments over a short period of years.
--Leaving more for heirs. That is, you don't need the money in the Roth account and want to leave an income tax free Roth IRA to your heirs for gift and estate planning purposes.
Keep in mind that this analysis offers broad perspectives on possible advantages of Roth conversions for a variety to people. A tax expert can verify whether these advantages apply to your situation.
Call me for a courtesy consultation, to see if a Roth conversion is right for you. For an appointment reach me at 415.472.1445, ext. 306.