If your traditional IRA is invested in stocks and/or mutual funds, the recent substantial downward slide by the stock markets may provide a unique opportunity to convert your traditional IRA to a Roth IRA at a low cost, and then benefit when the markets recover.
Why would you want to do that? Because Roth IRA distributions provide tax free retirement benefits while payouts from Traditional IRAs are taxable.
Of course there is no assurance that the markets will not continue to decline, and this may not be the most opportune time to make a conversion in your specific circumstances but is something you may want to consider. Conversions provide the most benefit to younger individuals who can look forward to many years of the tax-free growth provided by a Roth IRA.
You don’t have to convert all of your traditional IRA in one year. You can convert what you can afford to pay the tax on each year.
Here Is How It Works – The tax code allows individuals to convert any portion of their traditional IRA to a Roth IRA by paying tax on the conversion as though taking a distribution from the traditional account. Thus, if you make a conversion you are taxed on the conversion based upon the tax rates that apply to your normal income plus the traditional IRA amount being converted.
Of course, if in 2022 you have abnormally lower income, that could make the conversion tax even less. The following table includes the marginal tax rates for 2022.
MARGINAL TAX RATES |
|||||
|---|---|---|---|---|---|
| Year | Marginal Rate | FILING STATUS |
|||
Single | Head of Household | Married Filing Jointly | Married Filing Separately |
||
| 2022 | 10% | 10,275 | 14,600 | 20,550 | 10,275 |
12% | 41,775 | 55,900 | 83,550 | 41,775 |
|
22% | 89,075 | 89,050 | 178,150 | 89,075 |
|
24% | 170,050 | 170,050 | 340,100 | 170,050 |
|
32% | 215,950 | 215,950 | 431,900 | 215,950 |
|
35% | 539,900 | 539,500 | 647,850 | 323,925 |
|
37% | |||||
Example When Using the Table – Let’s say you are filing single and your taxable income without an IRA conversion amount is $45,000, which has a marginal rate of 12%, and you are converting $40,000. This brings your taxable income to $85,000, which is still in the 12% bracket (it’s more than $41,775 but less than $89,075, the start of the next rate). This means the tax on the conversion would be $4,800 (12% of $40,000). If you did the conversion in a year when your other income was more and when combined with the conversion amount you are in the 22% bracket, the tax on the conversion would be $8,800, $4,000 more than when you are in the 12% bracket.
Other Issues:
- There is no income limitation on making a conversion, thus anyone can do a conversion.
- Higher income taxpayers can use the conversion to circumvent the AGI limits for contributing to a Roth IRA.
- Once a conversion is made it cannot be undone.
- Some individuals for various reasons have made non-deductible contributions to their traditional IRAs. For distribution or conversion purposes, all an individual’s IRAs (except Roth IRAs) are considered as one account and any distribution or converted amounts are deemed taken ratably from the deductible and non-deductible portions of the traditional IRA, and the portion that comes from the deductible contributions would be taxable.
If you have questions or need assistance, contact the Experts at Henssler Financial:
- Experts Request Form
- Email: experts@henssler.com
- Phone: 770-429-9166
Disclosures: The investments referenced within this article may currently be traded by Henssler Financial. All material presented is compiled from sources believed to be reliable and current, but accuracy cannot be guaranteed. The contents are intended for general information purposes only. Information provided should not be the sole basis in making any decisions and is not intended to replace the advice of a qualified professional, such as a tax consultant, insurance adviser or attorney. Although this material is designed to provide accurate and authoritative information with respect to the subject matter, it may not apply in all situations. Readers are urged to consult with their adviser concerning specific situations and questions. This is not to be construed as an offer to buy or sell any financial instruments. It is not our intention to state, indicate or imply in any manner that current or past results are indicative of future profitability or expectations. As with all investments, there are associated inherent risks. Please obtain and review all financial material carefully before investing. Henssler is not licensed to offer or sell insurance products, and this overview is not to be construed as an offer to purchase any insurance products.
