In today’s blog we are in the area of retirement planning, and we’re going to go through some of the advantages of having a Roth IRA as part of your retirement plan and how it can benefit you.
First, just a quick refresher; in general Roth IRAs are tax free as long as you are age 59 ½ and have had the Roth opened for a minimum of 5 years. Traditional IRAs are tax deferred, so you are putting the IRS on hold and income taxes will be due later. To change (or convert) a Traditional IRA to a Roth IRA, you must pay income taxes on the converted amount. This conversion is taxed as ordinary income, NOT capital gains tax, there’s a big difference. Sorry, as nice as it would be, you cannot offset the conversion tax using long term capital losses.
Also, if you pay the conversion tax from a non-IRA source, you keep more tax‐free returns since you took money from a taxable asset to pay the taxes, and kept all the money in a tax‐free asset, the Roth IRA.
One very unique feature is that you can recharacterize a conversion if you change your mind and wish you hadn’t done it. Think about that. You can “undo” the conversion for any reason – like it never happened. How many times in life have you wished you could redo something?! For example, what if the market nose-dives after your conversion? Although you had terrible timing, you can undo it, if you want. You have until October of the following year to recharacterize. Again, this is a one of a kind and convenient feature.
Did you know there are NO Required Minimum Distributions (RMDs) at age 70½ for Roth IRAs like there are for Traditional IRAs? It’s true! This is a big advantage for the Roth IRA holder because it allows you to keep more of your money growing tax‐free. For example, let’s say Harold has a Traditional IRA with a $100,000 balance on December 31, 2015 and is 70 ½. Harold must begin RMDs at age 70 ½ and do so every year. Harold’s RMD would be $3650 for 2015. The $3650 is taxable income and revenue to the IRS. “Revenue” indeed is the IRS’s middle name!! If instead Harold had the $100,000 balance in a Roth IRA, Harold would not be required to take that $3650 RMD at age 70 ½ or any other age, he can just keep it in the Roth and let it grow tax free.
Conversions to a Roth IRA reduces the value of your estate, which can lower the effect of higher estate tax rates if you’re in danger of paying estate taxes.
Roth IRAs take it easy tax wise on a surviving spouse. If a Roth IRA owner passes away, income taken from a Roth IRA by a surviving spouse won’t send them into a higher tax bracket because the distributions are tax free. A surviving spouse will probably file as a single filer, and single filers reach higher marginal tax rates quicker than married filing joint couples do.
Beneficiaries of a Roth IRA can take income tax‐free. This may be the mightiest advantage of a Roth IRA or converting to one. It’s not just tax free to you or a surviving spouse, but can be to children and grandchildren as well. Wouldn’t this be a nice asset to pass on to a child in a high tax bracket? Now that’s planning!
Another factor to consider is if future marginal tax brackets go up, you will pay more tax on income from a traditional IRA. However, if future tax brackets go up, it might be cheaper to pay the tax on a Roth conversion now before tax rates go up.
Lastly, converting funds to a Roth IRA may help you avoid that annoying new 3.8% Net Investment Income Tax. It’s a process, but it can help. If you would like more details in this area, please don’t hesitate to contact us. Thanks so much for reading!
The content is developed from sources believed to be providing accurate information. The information in this material is not intended as tax or legal advice. It may not be used for the purpose of avoiding any federal tax penalties. Please consult legal or tax professionals for specific information regarding your individual situation. The opinions expressed and material provided are for general information, and should not be considered a solicitation for the purchase or sale of any security.