With the suspension of Required Minimum Distributions (RMDs) coupled with the market being down, this may be a good opportunity to consider a Roth IRA conversion.
In any given year, an investor who has to take their RMD can make a conversion, but they must take the RMD amount first, and then they may convert an amount above the RMD. For example, if your RMD is $50,000 and you want to convert $25,000, you would first have to distribute the $50,000 from the IRA, then convert an additional $25,000 for a total of $75,000 in ordinary income, assuming no basis in traditional IRA. This year you can simply convert the $25,000 and potentially be in a lower tax bracket or choose to convert $50,000 and remain in a similar tax position as in past years.
Why would you want to stay in a similar tax position? First, tax rates are historical lows and could go up. Second, you would be converting stocks while they are at depressed prices to a Roth account that grows tax free. Essentially, you would get more shares into a Roth when the stocks are down. When the stocks recover, you will experience tax-free growth in an account that does not have mandatory distributions. And third, the RMD calculations on your Traditional IRA are based on the account asset value as of the last day of the previous calendar year. If you reduce the assets in your Traditional IRA, your future RMDs and associated taxes could be lower.
Even if you are not RMD age (currently age 72), your income may be down for the year, making a Roth conversion more attractive. If your income will be lower in 2020 from loss of employment, a reduction in portfolio income such as capital gains, loss of rent, etc., you may want to consider a conversion.
If your income will be similar this year, it still may make sense to look at a Roth conversion to pay the taxes on a lower amount. For example, if your Traditional IRA was valued at $150,000 at the end of 2019 and now it is valued at $125,000, you can convert the account to a Roth IRA and pay taxes on the $125,000 now, allowing the stocks to rebound tax free. You can also do a partial conversion, as you do not have to convert the entire account.
Finally, the SECURE Act, which went into effect Jan. 1, 2020, forces all non-spouse beneficiaries of retirement accounts to distribute the assets within 10 years, effectively eliminating the stretch provision. If you convert your IRA accounts, you can pass Roth proceeds to your heirs tax free. They will still need to distribute all retirement accounts within 10 years, but there would be no tax on the distributions from a Roth versus the Traditional IRA, which would be taxed. This does not work in all situations, as you need to consider factors such as your heirs’ tax brackets versus your tax bracket; however, this provides another potential benefit for a Roth conversion this year.
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