The first four months of 2020 have proven to be unpredictable, volatile, and challenging. Despite recent market changes, there continue to be several planning opportunities that we are monitoring for our clients. One of these is Roth IRA conversions. Below are five reasons why investors might consider Roth IRA conversions in 2020.
- Market Decline - The stock market decline during the first quarter of 2020 has resulted in lower IRA account values in most cases. As a result, there is the potential to convert a higher percentage of your account to a Roth IRA today than you could have just three months ago. Below is an example illustrating the impact.
If you believe the market will eventually recover to its previous level and beyond, this strategy will result in a higher percentage of your net worth becoming eligible for tax free distributions in the future. - Rollover Restrictions - As part of the Coronavirus Aid, Relief, and Economic Security Act (CARES Act), Required Minimum Distributions (RMDs) were suspended for 2020. This has enabled some investors who already took distributions to now attempt rolling those distributions back into their IRAs. This type of rollover, with certain exceptions, is only allowed once every 12 months and must be completed within 60 days of receiving a distribution. Unfortunately, if an individual has taken multiple distributions this year, only one will be rollover eligible. Roth IRA conversions could be a great option for any previous distributions that are not rollover eligible. This is possible because Roth IRA conversions are not subject to the once-per-year rollover rule. However, Roth IRA conversions also must be completed within 60 days of the original distribution.
- Lower Taxable Income - The suspension of Required Minimum Distributions (RMDs) in 2020 could result in a reduction of taxable income. When completing a Roth IRA conversion, an individual pays ordinary income tax on the amount converted. If you fall into a lower tax bracket in 2020 due to a reduction in income, less tax will be paid on the amount converted. For example, a couple filing jointly who expect to have income of $90,000 would fall into the 22% Federal income tax bracket. Following the suspension of RMDs, their expected income falls to $60,000. They would now be in the 12% bracket, and any Roth conversion would be taxed at the lower rate, up to the top of the 12% bracket.
- Income Tax Rates – In 2017, the Tax Cuts and Jobs Act was passed. This resulted in a reduction in income tax rates for many individuals. This means that funds converted to a Roth IRA may result in a lower tax bill. For example in 2017, a married couple with taxable income of $200,000 filing a joint return was in the 33% tax bracket. In 2020, this couple with the same income would be in the 24% tax bracket. If you believe your personal tax rate will increase in the long run, then Roth IRA conversions might be a good strategy to reduce taxes.
- Beneficiary Considerations – The Setting Every Community Up for Retirement Enhancement Act (SECURE Act) became effective on January 1st, 2020. One of the results was a change in how beneficiaries are required to take distributions from Inherited IRAs. The SECURE Act eliminated the ability for most non-spousal beneficiaries to stretch distributions out over their life expectancy. Under current law, the entire Inherited IRA balance must be distributed within 10 years. This may result in a larger tax liability for the beneficiary. Roth IRA conversions may be an option for investors to consider when planning for non-spousal beneficiaries. Taxes will be owed in the same year as the conversion, but their beneficiaries will have the ability to access those funds on a tax-free basis.
As you can see, there are several factors that go into determining if a Roth IRA conversion will fit your situation. Prior to making any decisions you should consult with your financial planner and tax advisor.