The Roth Redo

With the tax filing season officially over on October 15th, I wanted to highlight a tax strategy that could help turn your IRA into a more tax friendly investment. I am talking about a Roth conversion… and, if necessary, a Roth redo as well.

Some investors who find themselves in a low tax bracket will often look at a Roth conversion as a way of keeping taxes low for the long term. By converting part or all of a traditional IRA into a Roth, you must claim the conversion amount as income on your taxes. Why would you want to pay taxes now that could be deferred to a much later date?

The primary reason would be if you believe your current tax rate is lower than what you anticipate paying in the future. Young investors that believe they will be in a higher bracket due to raises and promotions may find themselves currently in a low tax bracket after factoring in their current deductions. Paying the tax now, ideally at a lower rate, will take out some of the guess work of how much they will need to save for retirement.

New retirees may be in a similar situation if they are living off non-IRA savings and have little to The Roth Redo no taxable income. Paying the tax now, on their terms, will also help them avoid paying the tax on the government’s terms. When you reach the age of 70 ½, the IRS has a required minimum distribution (RMD) that you must take out of traditional IRAs and 401ks (with a few exceptions). Roth accounts do not have this requirement, making it easier on the investor and eventually the beneficiaries.

One of the most attractive features of a Roth conversion is that you can get a “do over”. For example, assume you convert $50,000 of your IRA into a Roth today and then next April (before you file your taxes) you discover your Roth is only worth $40,000 due to poor performance. You would be paying tax on an extra $50,000 but only getting the tax benefit on $40,000… unless you enact your “do over” called a Roth Recharacterization. This allows you to unwind the conversion as if it never happened as long as it is done before you file your taxes for that tax year (including extensions).

As always, there are rules and limitations to how this works, so definitely consult your accountant or tax professional to see if a Roth conversion may help your personal situation. See us if you think a conversion makes sense for you!

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