Financial planners are likely to have more clients ask if now is the right time for an IRA to Roth conversion, given that without any federal action, tax rates are set to rise January 1st of 2013. Federal rates are set to rise for all Americans, with the lowest bracket rising from 10% to 15% and the highest from 35% to 39.6%. Reasons why Roth IRA conversions are attractive and when it makes sense to make a conversion are discussed in a Wall Street Journal article.
Roth IRA Conversions Popular Ahead of Tax Rise
By Arden Dale
It could be a good time for your clients to convert if they are expected to always fall into the highest income tax bracket to take advantage of the currently lower tax rates. If you clients temporarily find themselves in a lower tax bracket, it could be a great time to convert. This can be typical of clients who are retired and not yet drawing or taking distributions from retirement accounts.
Taxes are one of the many unknown elements of financial planning. When advising a client on if a Roth conversion is right for them, there are several factors to weigh. “Anyone thinking of it needs to do some careful thinking. Figure out the tax bill, and whether it’s affordable now. Take into account future tax brackets. And, weigh how badly the money may be needed several years from now.” Roth IRA conversion do not pencil out for many cases. A Roth IRA conversion becomes most attractive to clients that have the money to pay the tax bill in a regular taxable account, don’t need the money for several years, and are temporarily in a lower tax bracket.
The graphic above is a great guideline for determining if a Roth IRA conversion is worth exploring for your client. Money Tree’s Distribution Solutions includes a dedicated Roth IRA conversion calculator to help illustrate whether or not a Roth conversion will save your client money over the long-haul. Here are examples of the two client types discussed in this article.
Example 1 – client who always falls in the highest tax bracket:
Let us say we have a client who is 62 today and is in the top income tax bracket with taxable income of $400,000. This client expects his taxable income level continue into the future and would like to see if converting $500,000 of an IRA to a Roth would make since assuming the top marginal tax rate will revert back to 39.6% next year. He does not need to pull any money from the converted Roth IRA. Here is a snapshot of the data input for this case.
Here is a portion from the summary of the reports, evaluating the results at the client’s age 80, showing a favorable case for a Roth IRA conversion in 2012, especially when paying for the tax due on conversion from an outside taxable account.
Example 2 – Client is temporarily in a lower tax bracket:
Let us say we have client who is 66 today, and temporality finds himself in a lower tax bracket with taxable income of only $50,000 as he just retired and not yet starting Social Security or RMDs. This client expects his taxable income to increase when he starts collect Social Security at 67 and when begins taking RMDs at 70. This client also has $500,000 in an IRA he would like to look into converting to a Roth. He won’t need to withdraw from the converted funds. Here is a snapshot of the data input for this case.
Here is a portion from the summary of the reports, evaluating the results at the client’s age 80, showing a favorable case for a Roth IRA conversion in 2012 – but only when he pays for the tax due on the conversion from an outside taxable account.