Roth conversion’s are worth a close look now, especially after new tax law.
Whether you are retired or not, this may be a great time to convert Traditional IRA (including those 401k rollovers) to Roth IRA’s.
Why now?
The New Tax Law. These may be the lowest tax brackets we see in our lifetimes!
As most of you have heard, about 90% of taxpayers are in lower tax brackets thanks to the new tax law. This means the income tax you would owe if you converted Traditional IRA account money to a Roth IRA is lower than prior to the new law.
Conversion means you “covert” and claim the amount you covert to a Roth IRA as ordinary income and pay the tax due on the following April 15th.
It doesn’t have to be an “all or nothing” proposition. You can covert a portion of your IRA and that is often what people do. People often determine the amount they will convert by looking at the federal income tax bracket table. As you can see if you find your taxable income amount (after deductions) you will fall in a bracket range.
For example:
A single person with a taxable income of $50,000 had the first $9,525 taxes at 10%, the next $9,526-$38,700 taxed at 12% and the amount over $38,700, but less than $82,500 taxed at 22%. The 22% is also called the marginal tax bracket. This is the tax rate on your last taxable dollar.
This is important to understand because often times people convert their IRA in an amount that keeps them in the same bracket as their marginal bracket.
Do You Really Understand Your Income Tax Bracket?
Why I contribute to a Roth 401k.
How much to convert in this example is simply $82,500-50,000=$32,500. That $32,500 would be added to ordinary income and taxed at the marginal rate of 22%.
If you converted more than that, the excess would be taxed at the next bracket rate of only 24%. That’s up to $157,000 for a single person and from the table above $315,000 for a couple filing jointly.
Again, the reason this is potentially so attractive is that income tax rates are historically very low. Therefore, the tax cost of doing the conversion is lower than normal when you claim the converted amount on your tax return.
There are other reasons to convert to a Roth IRA including the fact that you will not be required to take distribution later in life and will not have to pay tax again when you take distributions after the money has been in the Roth for five years.
How to Avoid Disastrous RMD Penalties
Especially with the new tax law taking effect in 2018, you should consult your tax advisor before making any conversion to know if it makes sense for you and what the expected tax consequences will be for you.
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