Last year’s tax reform legislation has lowered many folks’ federal income tax rates, which effectively makes Roth IRA conversions cheaper for many of those seeking to limit their taxes in retirement.
This is especially true for married couples, though, as CNBC reported recently. The new federal tax brackets “are more favorable for married people,” says Robert S. Keebler, a certified public accountant with the tax and accounting firm Keebler & Associates in Green Bay, Wisconsin.
For that reason, Keebler argues couples should convert traditional IRAs to Roth IRAs while both spouses are alive, CNBC reports.
What is a Roth IRA conversion?
When you contribute to a traditional IRA, you’re not taxed on the cash that goes into the account. Instead, money in a traditional IRA account — both your original contribution and the earnings it generates — is taxable later, in the tax year during which you withdraw money from the account.
By contrast, money you deposit in a Roth account is taxed in the tax year during which you deposit the money. So, if you follow the IRS rules for retirement account withdrawals, you get to withdraw contributions and earnings tax-free. That fact makes Roth accounts attractive to folks seeking to avoid taxation in retirement.
When you convert a traditional IRA to a Roth IRA, you pay income taxes on the converted money in the tax year during which you made the conversion. But the process ensures you will not be taxed on that money when you withdraw it in retirement — assuming you follow IRS rules for withdrawals.
How tax reform affected Roth conversions
If you convert money in a traditional account to a Roth account, the tax rate you pay on that money is the same as your federal income tax rate at the time of the conversion.
With tax rates now lower for many people and the new tax brackets also more favorable to couples, many Roth conversions will be subject to lower tax rates.
Your 2017 tax return was the last one subject to the old tax rates. Your 2018 return — the one due by April 2019 — is the first that will be subject to the new rates created by tax reform.
Is a Roth IRA conversion right for you?
An IRA conversion isn’t right for everyone — or even for every married couple.
Determining whether one is right for you depends on more factors than just your new federal income tax rate. For example, you must also consider how your current tax rate compares with the tax rate you likely can expect in retirement.
There are also income restrictions: If your income is more than a set amount, you can’t do a conversion. For example, a married couple filing a joint tax return currently must have a taxable income of less than $199,000 to convert money in a traditional IRA to a Roth IRA, and reductions begin at $189,000.
So, consider consulting a good financial adviser or accountant.
Additionally, the Tax Cuts and Jobs Act of 2017 repealed the ability to “recharacterize” a converted Roth account. As we detail in “Tax Overhaul Tweaks Some Rules for Retirement Accounts,” that effectively means that if you convert a traditional IRA to a Roth IRA, you will no longer have the option to undo the conversion. You’re stuck with the Roth.
Have you considered converting any retirement accounts after tax reform? Share your thoughts below or on Money Talks News’ Facebook page.