Income Tax Planning IRA Retirement Income Planning Roth IRA

The Roth IRA Conversion Trifecta

As a result of a series of three events, there’s an unprecedented opportunity to do a sizable Roth IRA conversion this year.

Those of you who have read my Retirement Income Visions™ posts and MarketWatch Retirementors articles over the years know that I’m a big fan of Roth IRA conversions. A Roth IRA conversion, when implemented timely, can be one of the most effective strategies for optimizing retirement income.

As a result of a series of three events, the most recent of which is unfortunately in response to the coronavirus pandemic, there’s an unprecedented opportunity to do a sizable Roth IRA conversion this year. Taking advantage of this opportunity is predicated on availability of cash to pay the income tax liability attributable to the conversion.

Event #1:  Stock Market Downturn

In less than six weeks, The Dow Jones Industrial Average (DJIA) plummeted 11,355 points, or 38.4%, from its high of 29,569 on February 12th to its recent low of 18,214 on March 23rd. While it recaptured 3,423 points this past week to close at 21,637 on Friday, the DJIA is down 26.8% from its high.

Keeping in mind that any appreciation in a Roth IRA account following a Roth IRA conversion will permanently escape taxation, this is one of those market-sensitive conversion opportunities, the likes of which we haven’t experienced in 11 years. Assuming that you’re healthy and you have a reasonably long planning timeframe, you or your financial advisors should be examining how you can take advantage of this.

Event #2:  Low Income Tax Rates Expire After 2025

The current historically low income tax rates and widening tax brackets to which they’re applied that went into effect in 2018 will end after 2025. Prior to the economic meltdown triggered by the coronavirus pandemic, there was widespread agreement that tax rates will increase in 2026, if not sooner. The signing of the $2 trillion coronavirus relief bill, or CARES Act, by President Trump on Friday piled on top of our national debt of $24 trillion makes this inevitable.

Knowing that you only have six years, including 2020, to pay income tax at a lower rate than you’re likely to pay in the future, Roth IRA conversions should be a high priority for most employees who have Traditional 401(k) plans with a Roth 401(k) option as well as Traditional IRA account owners.

Event #3:  Inherited Retirement Plan Lifetime Distributions Eliminated for Non-Minor Children

In addition to the likelihood of being subject to higher income tax rates, adult children and grandchildren will no longer be able to take distributions from inherited retirement plans over their lifetime. The “stretch IRA” has been replaced with a 10-year rule for most beneficiaries with the enactment of the SECURE Act that went into effect this year.

Most nonspouse beneficiaries, including non-minor children and grandchildren are now required to withdraw 100% of the funds from their inherited retirement plans by the end of the tenth year following the year of death for deaths occurring after 2019. This will accelerate distribution of assets and taxation at higher rates for beneficiaries of 401(k) plans and Traditional IRA accounts. Although distributions won’t be taxed, this change also applies to inherited Roth IRA accounts.

With the elimination of the “stretch IRA,” it no longer makes sense in many cases to leave sizable taxable retirement plan accounts to children and grandchildren. An aggressive Roth IRA conversion plan is one way to reduce, or potentially eliminate, this problem.

Transfer Securities When Doing a Roth IRA Conversion

I have had a number of clients and other individuals tell me that they thought that they need to sell securities in their Traditional IRA account in order to do a Roth IRA conversion. This is generally not a good idea given the fact that appreciation in a Roth IRA account following a Roth IRA conversion will permanently escape taxation.

Instead, you want to specify on your Roth IRA conversion form a number of shares of one or more securities that you would like to transfer from your Traditional IRA account to your Roth IRA account. These should ideally include equity securities, e.g., large or small cap value exchange traded funds or mutual funds, which are likely to appreciate. The total value of the securities being transferred should approximate the desired amount of your conversion, keeping in mind that the value and associated tax liability is likely to change between the time that your form is submitted and your conversion is processed, especially in the current volatile environment.

Unprecedented Opportunity

As a seasoned financial advisor, I’ve experienced, and have presented to clients, several windows of opportunity to create and optimize retirement income. The three events discussed in this post, two of which didn’t exist three months ago, are a Roth IRA conversion trifecta, or perfect storm.

The three events can be leveraged to do a sizable Roth IRA conversion this year as part of a staged, or multi-year, Roth IRA conversion plan subject to availability of cash to pay the income tax liability attributable to the conversion. This is an unprecedented opportunity that many of us probably won’t experience again in our lifetime.

By Robert Klein

Robert Klein, CPA, PFS, CFP®, RICP®, CLTC® is the founder and president of Retirement Income Center in Newport Beach, California. Bob is also the sole proprietor of Robert Klein, CPA. Bob applies his unique background, experience, expertise, and specialization in tax-sensitive retirement income planning strategies to optimize the longevity of his clients’ after-tax retirement income and assets. He does this as an independent financial advisor using customized holistic planning solutions based on each client’s needs and personality.