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There are a few things advisors must consider before recommending a Roth conversion to a client. First, you should identify the tax bracket the client is in today and the starting points of adjacent tax brackets. Commonly, advisors consider Roth conversions for their clients when they have significant room before the edge of a tax bracket.
By determining your client’s tax bracket in advance, you’ll be able to quickly find the optimal time to convert, calculate how much you should convert, and how much is too much. It’s essential to look at the lifetime impact of the conversion. By calculating the single-year impact of various conversion strategies, you can make an educated decision about the costs of a conversion. It’s crucial to be aware of and help clients avoid potential pitfalls like entering a new tax bracket, Social Security tax, or unnecessary Medicare expenses.
There are a few things advisors must consider before recommending a Roth conversion to a client. First, you should identify the tax bracket the client is in today and the starting points of adjacent tax brackets. Commonly, advisors consider Roth conversions for their clients when they have significant room before the edge of a tax bracket. By determining your client’s tax bracket in advance, you’ll be able to quickly find the optimal time to convert, calculate how much you should convert, and how much is too much.
It’s essential to look at the lifetime impact of the conversion. By calculating the single-year impact of various conversion strategies, you can make an educated decision about the costs of a conversion. It’s crucial to be aware of and help clients avoid potential pitfalls like entering a new tax bracket, Social Security tax, or unnecessary Medicare expenses.
As mentioned previously, the first step when determining how much one should convert to a Roth is understanding the client’s likely future tax bracket. If a client expects to be in the 22% bracket on average and wants to avoid withdrawals at that rate, a conversion might be advantageous. For example, suppose the client has a few years with lower income, perhaps right after retiring and before claiming Social Security. In that case, they may want to consider converting enough to fill the 12% bracket. Filling lower brackets intentionally in low-income years keeps those dollars from being taxed in higher brackets in future, higher-earning years.
Remember, tax brackets are progressive, so it’s unlikely that the client would want to convert the entire IRA. It’s also important to consider Medicare premiums. Medicare Part B and Part D premiums are based on modified adjusted gross income. For clients who are older than 65 or within two years of enrolling in Medicare, it is worth considering conversions to the point at which they would pay additional Medicare Part B and Part D surcharges.
The Tax Cuts and Jobs Act of 2017 significantly lowered marginal income tax rates for most people. The marginal income tax rate is the percentage a person is expected to pay on the next dollar of income. The marginal income tax rates are divided into seven different tax brackets. As a result of this tax rate cut, many retirees are now evaluating how much of their pre-tax investments they should convert into a Roth and how much is too much.
For instance, for clients who are likely to be in the 22% or 24% bracket for the rest of their lives, it may make sense to convert to the top of the 24% bracket since the next bracket is 32% — a full 8% higher. Also, for this group, consider the tax brackets of the client’s children. The Tax Cuts and Jobs Act will expire on Dec. 31, 2025, so adding Roth conversions to your clients’ retirement strategies can help them take advantage of the current tax situation while they still can. Recent Legislation and Roth Conversions While Roth IRAs have always been an incredible legacy vehicle, this option is more attractive than ever due to the SECURE Act of 2019 and the subsequent SECURE Act 2.0 of 2022.
These two pieces of legislation made several significant changes that affect those who focus on retirement income planning. Some of the changes include: Required minimum distributions now begin at age 73 for those born between 1951 and 1959 and will increase to age 75 for those born after 1960. These changes give the client a few more years to do Roth conversions to bring down those eventually required minimum distributions.
There is no longer an age cap on contributions to a traditional IRA. If the client has earned income on their tax return, they are eligible to contribute. This change creates opportunities for advisors. For instance, it’s common to have clients who work part-time in retirement. They have some earned income coming in but are probably mostly using non-qualified investments to live off of, and they won’t have required minimum distributions until the ages set forth in SECURE Act 2.0. Those clients might be able to make an IRA contribution and qualify for a $1,000 Saver’s Credit since they “look poor on paper.”