A common technique for taxpayers with large IRAs and relatively lower income is to engage in conversion of traditional IRA funds to Roth IRAs. A conversion requires the taxpayer to declare as income the amount converted in the year the funds are removed from the taxable IRA and transferred to a Roth IRA. The obvious benefit to this technique is that under current law future appreciation in the Roth IRA is not subject to income taxation while distribution of principal from the Roth IRA is likewise not taxed.
This year – 2020 – presents a special opportunity for many taxpayers to consider whether to engage in Roth conversions. Tax rates currently are fairly low for many taxpayers and the burden of RMDs has been removed for the calendar year. Even younger taxpayers may benefit since the CARES Act removes the 10% penalty on early withdrawals of up to $100,000 from an IRA. In addition, for many taxpayers income will be lower this year due to interruption, reduction or loss of employment connected to the pandemic and the related lockdowns.
Things to consider when evaluating a Roth conversion include current income and tax brackets, anticipated future income levels, the anticipated uses for future RMDs and other distributions from the existing IRA, how the tax on a conversion will be paid (from the IRA or from other sources), and more. Of course, we can’t really know what the future hold in terms of the markets and their performance, the government and their constantly changing tax laws, and even our personal situations. Your financial adviser or tax professional will be able to help you work through the advantages and disadvantages of a conversion and to understand the immediate impacts of such a decision. The unusual situation this year may be an incentive to take another look at the Roth.