It’s been quite a year—and as the end of 2020 approaches, many will breathe a sigh of relief.
Before your mind moves to 2021, though, be sure to take advantage of our fee-only financial planning services and review your finances with a trusted TrueNorth Wealth advisor, as many tax laws have changed. Even though the year has been rough in a lot of ways, 2020 might still be a great year for many taxpayers to perform a Roth IRA conversion.
To review, Roth conversions allow those with a traditional IRA or another retirement plan to roll out their pre-tax savings to a post-tax Roth. Income taxes are paid on the converted amount, but once the funds are in the Roth account, no further taxes will be owed by either the owner or his/her beneficiaries.
What makes this a great time to convert to a Roth? Here are six reasons:
Because of the economic impact of the COVID-19 pandemic, some have overall lower incomes in 2020. You should consider a Roth conversion to the top of your current marginal income tax bracket.
The CARES Act of 2020 (Coronavirus Aid, Relief, and Economic Security Act) suspended the required minimum distribution for IRAs and other retirement plans. These amounts can be rolled out to a Roth account if you don’t need them for monthly expenses.
Current lower tax rates could increase in the future. Due to both CARES Act spending and changes resulting from the election, there is a good chance that current tax rates are as low as they will be for years to come. You may pay a higher tax rate by waiting.
If you are retired and married, consider yourself fortunate. You are using the favorable married filing jointly (MFJ) tax rate schedule, and you are also likely receiving spousal Social Security benefits. These benefits will be partially lost if your spouse dies, requiring you to file using the single tax rate schedule. Consider preparing ahead by converting to a Roth while you can still file in the joint tax rate schedule, which can leave a tax-free cushion for your surviving spouse.
Consider your heirs’ tax rates. Most children are middle-aged when their parents pass away, placing them in the highest income tax bracket of their lives. While inheriting Mom and Dad’s IRAs is always a blessing, federal and state income taxes due on those IRAs can reach well over 40 percent. A key provision of the CARES Act now includes the requirement (with a few exceptions) to be fully taxed on the inherited IRA amount within ten years.
If the parent IRA owner is in the 12 percent bracket and pays taxes to Roth convert an amount each year, this alone could save the heirs more than 40 percent of their inheritance in taxes!
Locking in a Roth IRA’s tax-free growth with the rising equity markets becomes an extra benefit for you and your spouse.
There are also reasons you would NOT want to convert funds to a Roth convert in 2020, including the possibility that you may be paying a LOWER tax rate in future years. Be sure to consult with your TrueNorth Wealth fee-only financial planning advisor on your best timing.