The Macro View

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Over the last 8 weeks the world has changed.   The exact changes are not yet known but certain probabilities that impact long-term financial planning have shifted.   We believe these changes have made ROTH conversions a more important strategy than ever for young savers looking to reduce their future tax burden and for older savers looking to maximize wealth transfers to their kids.


1. Asset prices are down 

Converting IRA investments to a ROTH IRA when asset prices are down allows you to minimize the amount taxed at conversion time and allows the investment gains from the rebound to be housed in the tax-free ROTH IRA.   

As an investor you are well aware that stock prices fell swiftly from the end of February to late March and while they have rallied since, the S&P 500 is still down more than 10% YTD as of the end of April.  Further, it is likely your IRA was diversified and includeother types of investments like small-cap stocks, international stocks and REITS that are down more than large-cap US stocks.   Rather than abandoning these positions altogether you can sell them in your traditional IRA, convert the cash to a ROTH IRA and then buy them back in the ROTH IRA.    Sheltering all eventual appreciation from future taxes. 


2. Income may be down 

Unfortunately, many people will likely experience a reduced amount of income in 2020 which means you may end up in a lower tax bracket.   The amount of assets you transfer from your Traditional IRA to a ROTH IRA is treated as taxable income in the year that you make the conversion.  Even if you are fortunate enough not be laid-off or furloughed, you or your spouse may experience a reduction in hours, bonuses or commissions and business owners may see less profits or even losses.   The silver lining for those looking for long-term tax savings is that the tax on the conversion may be lower. 


3. No Required Minimum Distributions (RMDs)  

Another cohort that may see less income in 2020 are those over age 70.5 who in typical years are required to take distributions from their Traditional IRAs whether they want the income or not.   The IRS has waived RMD requirements for 2020; which opens the window of doing a ROTH conversion for the amount that you would have taken as an RMD and being in the same tax position as you would have been in had the RMD’s not been waived.   The benefit of the conversion vs. the RMD is that the money can find it’s way into a tax-free ROTH IRA for use later in your life or for a more efficient transfer of wealth to kids and grandkids.  For more on that keep reading.


4. 2017 Tax Cuts (TCJA) are still in effect 

To combat the economic damage of the Covid-19 pandemic the government has thus far spent over an estimated amount of $6T compounding a budget deficit that was already at record levels and increasing the probability that we will see a highertaxes in the future.   The 2017 tax cuts are due to sunset or expire after 2025 at which point the tax rates will revert back to pre-2017 levels.   The probability has now increased that Congress will allow the cuts to expire or re-write the tax code in 2025 in a way that raises more revenue- either way the result is likely to be higher taxes especially for higher income and wealthier households.


5. SECURE Act complicated the inheritance of Traditional IRAs  

In December, the SECURE Act was introduced which made major changes to the retirement plan landscape.  The Secure Act did away with beneficiaries of IRA’s being able to stretch the RMD’s over their lifetime and now requires that the entire amount of the inherited IRA be withdrawn within 10 years from the date of inheritance.    

Notably, this provision applies to non-spouse beneficiaries (most frequently the original IRA owner’s children) which creates the potential for a significant loss of wealth during the generational transfer and a potential tax burden to the kids.  Often times the next generation beneficiary is in their peak income earning years therefore they often do not have a need for the inherited funds and are in a high tax bracket.   While inherited ROTH IRAs still must be withdrawn within 10 years the withdrawals will not be taxable improving wealth transfer and not complicating the beneficiaries tax planning. 

If you believe your income or your beneficiaries income will higher in the future; if you believe tax rates are likely to be higher in the future and if you are motivated to maximize your wealth transfer plan then 2020 is the time to take a closer look at a ROTH conversion.



Written by – Chris Thomas, CFP®, AIF®, CPFA

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