August 19, 2014

Roth Conversion Strategy

A Roth IRA conversion is the movement of money from a SEP, Simple, or Traditional IRA into a Roth IRA.  The funds converted are considered taxable income.

We wanted to briefly touch on one timing strategy that we have been utilizing quite a bit with our clients. 

The typical profile of this client is mid 60s, retired or having downsized employment recently. When cash flow is not an issue we are often utilizing social security claiming strategies that delay the bulk of the benefit until age 70.  This coincides with the time when you need to begin taking Required Minimum Distributions (RMDs) from your IRA accounts (age 70.5). 

So, you are 65, have been in a high tax bracket for the past 20+ years, therefore you have been deferring as much income as possible into 401k plans, deferred compensation plans, etc. to avoid paying taxes in those years.  Because of this, you have accumulated most of your wealth in IRAs, after-tax investments, and real estate - with very little in tax-free growth vehicles such as Roth IRAs. The high IRA account values mean you will have a large required taxable distribution from your IRAs beginning at 70.5.

Having retired, there is a period of time between your mid- 60s and age 70 when you may be in a lower Federal and State income tax bracket. 

It is during these years where it may make sense to convert some of your Traditional IRA assets into Roth IRA assets, and pay taxes at this lower tax rate.  This could also help keep your income lower post 70.5 as your RMDs from the IRA accounts will be lower.  It can provide greater tax diversification of your assets in the future which can be helpful during distribution planning.  Also, Roth IRA assets are more preferable than IRA assets for future generations to inherit, as the income tax burden will not be passed along to them.

Of course, each situation is unique and there are multiple facts to understand and explore to ensure that a Roth conversion is appropriate in your situation.  There are also many other times in ones financial life when a Roth conversion could make sense.  We simply wanted to point out one common situation with our clients where we have been able to effective implement this planning strategy.