Wow! It is hard to believe we are in the third quarter of 2022 already. With all the market volatility, most people will be happy to see their calendar change. Before we turn the page in 2022, there are some year-end tax and retirement strategies that you may need to start considering now before the clock runs out on the year.
With the decline in both the bond and equity markets, most of us have seen a dent in our retirement accounts. This opens a great opportunity for those that are either (1) in higher tax brackets, or (2) that don’t want or need required minimum distributions (RMD) if they are reaching 72 years of age. Whether you think tax rates will be going up in the future or not, I think everyone would agree that rates are certainly not going down. If we can agree on that, then we should also be able to agree that reviewing a systematic plan to convert a portion of your IRA or 401(k) assets to a ROTH account should also be in order. With the decline in current market values, conversions can be done now at lower values which means lower tax exposure. As markets recover, the growth of those investment dollars will be tax-free and never again subject to unwanted mandatory annual RMD.
The ROTH Conversion has been around ever since the ROTH IRA, named for Senator William Roth, was created by the Taxpayer Relief Act of 1997. By creating a conversion plan based on individual financial situations, the goal is to fully take advantage of your current marginal tax rate from one year to the next. For example, in 2022 a couple filing jointly making $125,000 per year would be in the 22% marginal bracket. Their marginal rate would not cross into the 24% bracket until their income exceed $178,150. That means they have room to convert $53,150 from existing retirement accounts to a ROTH account without moving to a higher bracket ($178,150 - $125,000 = $53,150).
By gradually filling up those lower tax brackets, you can accomplish several goals depending on your financial situation. For example, if you had plenty of income from other sources and were not planning to touch those assets, converting those dollars to a ROTH would eliminate any RMDs for the rest of your life. This will allow those untouched dollars to grow tax-free and pass to your heirs completely tax-free down the road.
On the other hand, if taking income from your retirement accounts is needed, by converting to a ROTH account you can choose how much and when you need that income, not Uncle Sam. But perhaps more importantly, those dollars would be completely tax-free, which is important if tax rates rise. It is also important to note that income from a ROTH account is one of the few incomes not included in calculations that determine at what level your Social Security benefit may or may not be taxed. That portion could be as high as 85% of your benefit. Nor does it go into the calculation to determine any additional Medicare premium taxes that may be required on high-income earners. Depending on the effects of inflation, this could be very important in the later years of your retirement.
As noted above, anyone is eligible to convert all or some of the assets held in their retirement accounts to a ROTH IRA. No matter your age, you should take the time to review this option with your financial and tax advisors to see if making such a change makes sense for your personal financial situation.
However, it is important for older retirees--those currently 72 or older – to remember that your RMD requirements are not eligible to roll over to a ROTH account. Stay tuned for part two of this series, we have a solution for this issue as well.
By taking advantage of the current market declines to jump-start a systematic ROTH conversion process, a retiree can lower their future tax exposure and lock in the lowest income tax rates in history now and possibly grow a bigger legacy for their heirs in the future.
If you would like a personal review of how a personalized ROTH conversion plan would benefit your individual situation or get answers to any questions you may have, feel free to reach out and we can schedule a quick 10-minute call at your convenience.
George “Lisle” Cheatham, II is a Certified Financial Fiduciary®, owner of American Financial Consultants, Inc. Securities offered through NEXT Financial Group, Inc. Member FINRA/SIPC. American Financial Consultants, Inc. is not an affiliate of NEXT Financial Group, Inc.