Five Windows
ROTH CONVERSION OPPORTUNITIES
We have discussed the benefits of the ROTH option for your retirement plans several times in our blogs including Eliminate the Uncertainty of Future Tax Rates. So if you are interested in the five best windows in time to make a ROTH conversion, please keep reading. If you are more interested in the Scottish literary classic Five Windows or a beer from Five Window Beer Co., we are not much help.
Quick Refresher - ROTH retirement funds are not taxed when withdrawn in retirement. That includes the original contribution made with post-tax money and the subsequent investment growth. ROTH retirement accounts can be funded two ways:
an initial contribution to a designate ROTH retirement account like an IRA or 401(k). This contribution is made with after-tax funds.
a ROTH conversion from a traditional retirement account to a ROTH designated retirement account
A ROTH conversion does create taxable income in the year of conversion so planning is vital to maximizing your life time tax savings. Here are five windows of opportunities to make the most of a ROTH conversion:
1) When the Market is Down - A significant downturn in the stock market that drives the current value of your traditional retirement funds down presents one of the best opportunities to do a Roth conversion. You will pay the conversion tax on less money being converted. For example, if your traditional IRA was $100,000 and dropped to $70,000 when the market fell, you’d be converting and paying taxes on the lower amount. The whole reason you are converting money to a Roth IRA is to be able to withdraw it tax-free in retirement. Converting when the market is down allows you to convert a larger portion of your account for the same cost and when the market bounces back, you will get tax-free growth on the money you converted.
2) When you are Anticipating a Change in Tax Rates or Tax Brackets - If tax rates and brackets are predicted to increase, as is the current situation with the expiration of the TCJA rates at the end of 2025, you could save substantial conversion tax by converting before rates increase. Unless the TCJA brackets are extended by Congress, the 22% bracket is slated to increase to 25%, and the 24% bracket will go up to 28% for 2026. With historically low tax rates right now, converting a traditional IRA/401(k) to a ROTH may make good long-term sense, even if the tax hit now hurts a bit.
3) When you are Between Retirement Age and RMD Age - If you are a high achieving practice owner in the top tax brackets, you should hold off on any ROTH conversions until the early years of your retirement. Generally, your lowest taxable income level will be after you retire but before your RMDs (Required Minimum Distributions) from your traditional accounts and Social Security benefits begin (this will be in your early to mid-70s). This time frame may provide an ideal window to make a ROTH conversion by taking advantage of your lower early retirement income tax bracket .
4) When you are in a Low Income Year - The silver lining of a less profitable year for your practice is that it may put you in a lower tax bracket and create a window to convert pre-tax retirement accounts into a ROTH. It would be wise to wait until near the end of your low-income year to make any conversion because you’ll have a better idea of your total income and your marginal tax bracket.
5) When you are Planning Ahead for Your Heirs - While new rules on distributions by non-spouse heirs have reduced the effectiveness of the ROTH in estate planning, passing along a ROTH to your heirs (spouse, children and grandchildren) does not come with a tax bill for the heirs like a traditional retirement account would. If you can afford to make a ROTH conversion at a low bracket than your heirs would upon inheritance, a ROTH conversion may make sense from a total family tax burden perspective.
Reminder - You do not need to convert all of your traditional retirement funds at one time. You can spread out those conversions over multiple years, limiting your tax hit and converting amounts that enable you to stay in your desired tax bracket.