Want some more Roth dollars in your retirement accounts? Who doesn't! The quickest way to add some Roth funds could be through a Roth conversion, but timing is everything. The key to making the most of your conversion is arbitraging tax rates.
Here's a hypothetical. Johnny Football, a poor decision maker but gifted athlete, decided to perform a Roth conversion while he was under contract for a troubled NFL team. During the time of his conversion, he was making the most money of his working career. He converted $100k of his Traditional IRA and paid tax at 39% on his conversion, creating a $39k tax bill. Now, if Johnny waited until he was dropped from his contract and converted while he was unemployed, he would have paid no more than 25% in taxes, thus creating potential tax savings of at least $14k.
So When is the Perfect Time to Convert?
For many people, the best time to convert is after retirement but before collecting any Social Security, pension, or taking any retirement draws. I call this "the gap years." During the gap years, taxable income could be at the lowest levels in your adult life, so take advantage and convert!
For business owners, take advantage of a down year or a loss.
Other things you can do to lower your tax burden if you intend to do a conversion are maxing out your pretax retirement contributions and/or HSA in the year of conversion to lower your taxable income. If you're a business owner, many more tax reducing strategies exist, such as buying equipment and prepayments for cash basis taxpayers.
Tax Rates Could Rise, Roth Rules May Change
If you look at the history of tax rates and compare top tax brackets, today's top rate of 39.6% is relatively low compared to where rates and brackets have been. It's difficult to speculate on what Congress and the IRS will do, but many signals exist that point to increased taxes down the road. This only strengthens the importance of having Roth funds that can be distributed tax-free. Don't think the Roth IRA isn't fair game for being changed either. The contribution limits, thresholds and conversion rules could change too if the US government thinks Roth funds are a little too sweet.
Dial In Your Conversion With a Good Tax Accountant
A good tax accountant should be able to assist with your conversion. They should be able to assist with how much to convert to bring you up to the top of the targeted tax bracket. You’ll want to talk with them in the fall, since conversions must be performed by December 31st.
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