With all eyes on the tight presidential race between Vice President Kamala Harris and former President Donald Trump, some investors are taking matters into their own hands to prepare for potential policy changes instead of sitting on the sidelines. They are making tax-savvy and estate planning moves by contemplating Roth conversions to save on taxes and set their kids up financially no matter who ends up in the White House.
Protections from tax policy changes
Paying taxes now, with the luxury of tax-free growth for the rest of your life, makes sense if you are concerned about policy changes spurred by the White House and expect higher tax rates in the future. While taxes are one of the many hot topics in the presidential election, few realize that current tax rates are historically relatively low, with the top income tax bracket maxing out at only 37%, vs rates that were much higher in the past.
Managing during uncertain times
Setting up a Roth IRA conversion plan will help you keep your anxiety levels from rising as the election nears and the political direction of the United States continues to be uncertain. One of the best ways to deal with stressful times is to control what you can control, and in this case, it is taxes. IRAs and other tax-deferred accounts are really IOUs to the government. You will have to eventually pay taxes on this money when you take withdrawals.
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Smart investors are taking the control back from the government and making a strategy to pay these taxes when it is most advantageous to them.
What exactly is a Roth IRA conversion?
A Roth IRA conversion involves moving money from a traditional or rollover IRA to a different account known as a Roth IRA. The IRS will require you to pay taxes at ordinary income rates in the year you make the switch, but the upside is that the dollars in the Roth IRA will grow tax-free and are not subject to required minimum distributions (RMDs) over your lifetime.
Everyone can convert all or part of their IRA to a Roth IRA regardless of how much money they make from a salary, investments or other sources. This is excellent news, especially for those with higher incomes above certain levels ($161,000 for single tax filers and $240,000 for married filing jointly taxpayers), who cannot contribute directly to a Roth IRA.
When is the best time to convert?
There are many factors to consider when planning the ideal time to convert, and much of this depends on your specific tax situation, income, retirement goals and financial planning strategy. However, the optimal timing for a Roth conversion is when your income is lower. If you are unemployed, working part-time or are still waiting to start Social Security and not required yet to take RMDs, it could be the right time to start conversions.
Planning for conversions is critical. An essential strategy for conversions is doing scheduled transfers to a Roth IRA over several years to keep taxes lower vs moving a large lump sum all at once. Converting smaller amounts allows the investor to manage their tax situation better and plan for the necessary taxes to be paid.
Ideally, you want to stay in the 22% federal income tax bracket. To do this, you can work with your accountant or financial adviser to estimate your total income for the year and add to your income the amount you hope to convert.
For example, if you are in the 22% tax bracket, you will calculate how many dollars you can convert until you are pushed into the next tax bracket, 24% in 2024. If you convert $10,000, you can expect to owe $2,200 at tax time in the 22% bracket and would owe $2,400 at the higher 24% level. For some individuals, paying taxes on the Roth conversion at the higher 24%, 32%, 35% or even 37% federal income tax rates may make sense if they expect their tax bracket to be higher in retirement. Higher tax brackets can occur when RMDs, pensions and Social Security benefits kick in.
While the stock market continues to make headlines, reaching new highs in 2024, savvy investors are wise to convert immediately after a market pullback. When the value of your retirement accounts drop during a market downturn, you can convert more shares of your stocks and bonds at lower values. This can decrease the amount of money you will owe in taxes while the shares will be in an account and benefit from tax-free growth when the market rebounds, making your money work even harder for you.
Estate planning: Setting your heirs up for success
Roth IRAs play an essential part in smart estate planning. Roth IRAs can provide a lucrative financial benefit to your children or even grandkids when they inherit a tax-free account that can continue to grow for up to 10 years after your death. A Roth IRA is the most beautiful gift because it does not come with the tax burdens of traditional IRAs or 401(k)s. This preserves more of your wealth that you can pass on to your loved ones and offers much more flexibility for beneficiaries. Your heirs can take distributions anytime during the 10 years without worrying about a significant tax bill.
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This article was written by and presents the views of our contributing adviser, not the Kiplinger editorial staff. You can check adviser records with the SEC or with FINRA.
