Best Time to do a Roth Conversion

let's talk about the best time to convert an IRA to a Roth so I'm a big fan of Roth IRAs you get tax-free growth tax-free withdrawals there's no required minimum distributions they're great accounts now the thing about a rollover the only drawback you have to pay taxes on the amount that you convert so let's look at some of the best times to convert my name is Scott cotfield I'm a CPA and a CFA charterholder and I am the founder of Sophos Wealth Management so the biggest the biggest item you're going to look at is whether your current tax rate is lower than your future tax rate pretty simple now it's going to really depend on two things right first is your taxable income is your taxable income today lower than in the future than with no changes in the tax code it might be advantageous to convert your tax rate today will be lower than the future when your taxable incomes higher but there is a second component that is far more complex and that is what future tax rates are going to look like now currently thanks to the tax cut and jobs act we are set to revert to 2017 tax rates at the end of 2025 meaning tax rates are going to go up for everybody pretty much um in addition to that if you kind of look at everyone the overall fiscal situation you look at where Federal deficits are at if you look at just overall debt to GDP it's pretty clear things are unsustainable right now um so I think it's a good bet that future tax rates and on average will be higher than current tax rates now further backing this up if you look at the history of marginal tax rates in the U.S the at least the top federal tax rates have been much higher historically in fact for much of the period from say 1930s through about 1980 the highest marginal tax rate for high earners in the U.S was often over 70 percent so drastically higher than those rates are today um another factor that you that kind of can make for a good timing to convert is if you expect significant future investment growth often this happens after a big correction in the stock market so you kind of get two benefits here big Crush in the stock market typically means your portfolio has taken a hit so the amount that you convert you're going to pay less taxes on because it's a smaller amount and then your expected future returns are higher so it's advantageous not to pay taxes on that much higher future amount if you think back to say 2009 if your portfolio had kind of taken a hit from 07 to 09 and you did a conversion then all the growth that has happened from 09 until today would be tax-free and if you were to take all that money out you would not pay any taxes on it so that would have been a very advantageous time to have done a conversion now part of that investment growth too is just how long you can leave that money in there there's not a whole point a lot of point in converting if then over the next couple years you're going to just take distributions out of that um another thing that you're going to think of in terms of these conversions is whether it makes sense to do it all at once or if you want to spread it out do partial conversions now in practice I see kind of two times that makes sense for people to convert younger people say you're leaving a job or something like that younger people are typically on the low end of their long-term taxable earnings um you know as their career progresses their future taxable income is going to be much higher so it can often make sense for them to just go ahead and pay taxes on what is often a smaller balance in an IRA and do the conversion now so that they get tax-free growth in the future there's also kind of a golden opportunity for those in that 60 to 70 age range you are especially if you're already retired you can you've got a lot of levers you can pull tax wise you can delay Social Security you don't have any required minimum distributions or rmds from your IRAs so you can kind of play with your income and you can plug in some taxable income by doing partial conversions for a few of those years between 60 and 70 if you no longer have wage income so there's kind of a lot you can do planning-wise there I do want to to bring up a big note of caution and you know it's kind of the idea hey A Bird in Hand is worth two in the bush so I remember back uh I was talking with the CPA we had a mutual client and we were discussing whether we should do a Roth conversion for a client who was interested in it and he said he almost never recommends Roth conversions and I said huh that seems that seems odd like what's the rationale there said I just never want my clients to voluntarily pay taxes we don't know what the future is going to look like tax rates are a political decision they could easily go up so why should we voluntarily pay taxes that are not required today um it just doesn't advise it and I think you know there is some wisdom there um you have to keep in mind that we don't know the future tax code in fact if you look back a couple years ago when Congress was coming up with the build back better act one of the proposals there was an R rmd on Roth IRA accounts well on Ross and just all accounts regardless of age for both High net worth individuals so whether that's high earner or people with high balances so that would have been an rmd regardless of age so you could be 40 but if you had a big enough balance in your retirement accounts or if you were a high uh high enough earner you would have had to have done rmds from Ross and other accounts regardless of age so you never know the tax benefits in a Roth could also be means tested in the future uh you know I don't know if these are going to happen or not but I think you have to Discount the potential future tax savings given the fact that there are uncertainties whether those will still be there or not um so yeah that's something to take into account I think if you're considering a Roth conversion you know if you want to do a lot of projections this is where Financial professionals can really become in handy does it make sense to do a full conversion does it make sense to do a partial conversion do you have the money elsewhere to pay the taxes so if you've got a 200 000 account uh it'd be nice to roll the whole 200 000 into the Roth and not have to set some aside for taxes so hopefully you have other money set aside for those taxes uh all things to kind of consider when you're doing this the math especially for those in that kind of 60 to 70 age range can get pretty complex but again there's a lot of benefits to having money in a Roth so it's nice when you can do it I'm always happy to talk to you about your situation if you'd like to reach out and feel free to like And subscribe appreciate you guys tuning in

Channel: Sophos Wealth Management, LLC

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Id: H_WMCxWif6g

Length: 7min 8sec (428 seconds)

Published: Tue Aug 08 2023