Now more than ever you need to be careful with your Roth Conversions.
The 2017 Tax Cuts and Jobs Act (TCJA) made the Roth IRA conversion more appealing, but also trickier.
The reason the Roth IRA conversion looks really good now is because the new tax law has temporarily created lower taxes for most households. So taxes are essentially "on sale." Then starting in 2026 taxes will likely be going back up. To take advantage of today's lower taxes, a lot of investors are moving money from their IRAs to their Roth IRAs. That way they're paying lower taxes now to avoid potentially bigger taxes in their future.
That's perfectly sound reasoning to do the Roth IRA Conversion. And in many cases, it can be appropriate to convert a portion of your IRA money to your Roth IRA to help limit the impact taxes have on your retirement. But in some cases this shift of moving money from an IRA to Roth IRA can do more harm than good.
The old safety net that let you fix a bad Roth IRA Conversion is gone.
Prior to the 2017 Tax Cuts and Jobs Act, you had the freedom to undo an unsuccessful Roth IRA Conversion. Today, however, this "do-over" provision has been eliminated.
Which is a shame, because the ability to undo a Roth Conversion helped a lot of investors fix mistakes that would have otherwise resulted in...
- Falling into higher tax brackets
- Higher capital gains taxes
- Bigger taxation on Social Security benefits
- Increased Medicare premiums
Your Roth IRA Conversions have to evolve to suit the new rules.
Today the old rules for converting your IRA to a Roth IRA - that said to convert earlier in the year - are in many cases no longer smart to follow. The reason why is because current law says you CANNOT undo a Roth IRA Conversion. So converting early in the year then holding your breath to see the outcome can lead to tax surprises, which you CANNOT undo.
There's a new (safer) approach for Roth IRA Conversions.
The Roth Conversion planning process we recommend is designed to protect investors from these unexpected taxes and increased Medicare premiums, while still allowing them to get more of their retirement money growing tax-free.
Our Roth Conversion planning process requires 3-steps...
If you're sensing that a conversion will potentially help you, it's best to first...
Forecast the results of your Roth IRA conversion in advance (before committing to it).
When you forecast, you're simply projecting different scenarios.
To help our clients with this, we use a tax-planning software that shows us any potential red flags. We refer to this forecasting as your "tax-map." And we recommend completing this annually, or more frequently if things change like tax law or your personal circumstances.
Our "tax map" helps bring into focus the appropriate amount to convert (or not convert). It also shows you other tax planning opportunities and potential pitfalls.
After you've projected different scenarios you're then able to easily...
Identify the safest and smartest amount to convert.
Delay your Roth IRA Conversion as long into the year as possible.
(This is in stark contrast to the old technique that recommended you complete the Roth IRA Conversion as early in the year as possible).
You have to be certain. And the only way to be certain is to know exactly what your income is for the year, and what your taxes will be. For a lot of people, this means waiting until December so they can look back and accurately assess their year's tax situation. As such, we actually recommend completing another tax-map just prior to executing your conversion. This helps ensure you're converting the optimal amount from your IRA to your Roth IRA.
***Important note: December 31st is the deadline to make a Roth IRA Conversion. But to be safe it's best to give yourself a cushion to account for logistical and human error, and also the temporary increase in customer service requests due to other year end tax-planning strategies. That makes the optimal time to do your Roth IRA Conversion early to mid December.***
By completing an accurate tax forecast and waiting until the end of the year, you can avoid unexpected tax increases and identify the best amount to convert from your IRA to your Roth IRA.