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Is it Time for Clients to Convert to a Roth?

Updated: Apr 16, 2021

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With incomes being lower across the board for most clients, juxtaposed with the relatively low tax brackets of the TCJA, it may be time to convert from a Traditional IRA to a Roth. In converting to a Roth IRA, I understand that there will be a tax due, however this can all be eaten up with either a net operating loss or a relatively small tax bill.

When converting from a Traditional IRA to a Roth IRA there is a tax due on the original avoidance of taxes on the IRA. But after converting to a Roth there is no tax due upon withdrawal, provided that the money has been in the Roth for five years. If you are less than 59 ½ upon withdrawal there is usually a 10 percent penalty. However, if you are over age 59 ½ there is no penalty.

With incomes being down in 2020 the taxes associated with a conversion should be nominal at best. One of the best aspects of a Roth IRA are there are no required minimum distributions (RMD).

Back Door Roth

When someone is covered by an employer plan at work, or if they exceed the adjusted gross income (AGI) to contribute to a Roth, you can contribute to a non-deductible Traditional IRA, and then automatically convert the IRA to a Roth. The only tax due would be on the earnings the Traditional IRA made until the conversion.

It goes without saying that no financial matters should be based solely on the tax ramifications. Make sure that if you have clients convert from a Traditional IRA to a Roth that you run the numbers.

The new tax brackets may be low, but if you have to use all the money from the conversion to pay the taxes on then it wouldn’t be a good idea to convert. Remember, you can do a partial conversion of a Traditional to a Roth. So, those with clients that have a large sum in their IRA can strategically convert to a Roth through a number of years.

If you are looking for a tax deduction and the taxpayer’s AGI is too high for a Traditional IRA, or they are part of an employer plan at work, you might want to look into a health savings account (HSA). To contribute to an HAS, you must have an eligible high deductible plan (HDHP).

For individuals, a HDHP is $1,400 or more with a maximum out of pocket of $6,900. For a family, a HDHP is $2,800 or over with a maximum out of pocket amount of $13,800. The contributions are tax deductible above the line like a Traditional IRA and there are no AGI requirements.

The contributions can be invested in mutual funds and other securities. They grow tax-free and if they are taken out for medical expenses they are tax-free. The best part is if you don’t use the money in the year contributed, the unused amount rolls over to the next year.

In retirement, 70 percent of your health costs are related to medical expenses. Instead of taking money out an IRA and consequentially paying income tax on the withdrawal, the taxpayer can take the cost of medical expenses out of the HAS tax-free.

If you are single you can contribute $3,550 to an HSA. If a client is age 55 or over, they can contribute an additional $1,000. If married, they can contribute $7,100.

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