Some recent tax changes signed into law by former President Donald Trump have complicated Roth conversions. In response, financial professionals are reassessing their approach to this critical tax-bursting resource. Roth conversions let you move pretax or nondeductible individual retirement account (IRA) money into a Roth IRA. Though they’ve been a favorite for holding down median-effective tax brackets, the new tax landscape poses new questions on their optimal use.
According to Patrick Huey, a certified financial planner (CFP), the fundamental principle behind Roth conversions is managing tax brackets strategically. “Roth conversions are all about tax bracket management,” he explains. That requires deep consideration of dozens of financial metrics to figure out each client’s best path forward.
That’s why Judy Brown, a certified public accountant, calls for an honest, complete evaluation. “We are looking at a lot of different pieces, and figuring out the optimal place for each client,” she said. This complex approach is proving to be more vital than ever. Trump’s legislation brought lower tax rates to stay, but it added dozens of temporary tax breaks, each with their own income teeth.
Roth conversions are looking especially alluring at the moment. Lower tax rates will not be here for long, so take advantage of this window of opportunity! Owners/brokers/underwriters that work on these deals all advise creating funds at 22% or 24% tax rates. This strategy gets you under the 30% higher brackets that will hit you with big required minimum distributions (RMDs) down the road. Most retirees must begin taking RMDs from their pretax retirement accounts starting at age 73, or they risk incurring IRS penalties.
For example, advisors commonly attempt to fill the lowest tax brackets when executing Roth conversions. Future inflationary gains from such conversions may trigger newfound IRMAA (income-related monthly adjustment amounts) for Medicare Part B and Part D premiums. This should be an important issue to all approaching, or already on, Medicare.
The temporary tax breaks available from 2025 through 2028 may provide additional opportunities for Roth conversions before individuals reach the next tax bracket. Experts warn that once these cuts expire, investors could find themselves “paying more for the exact same Roth conversion,” as noted by CFP Ashton Lawrence.