Have you considered a Roth conversion for your individual retirement account?

There are two types of accounts that taxpayers can use to save for retirements. These are the Roth individual retirement account, or IRA, and the traditional IRA.

A Roth IRA is one to which contributions to the account are made with money that has already been taxed. A Roth IRA can be an account or an annuity. However, to be a Roth IRA, the account or annuity must be designated as a Roth IRA when it is opened. The contributions to the Roth IRA grow tax-free and any gains are not taxed upon with withdrawal provided the holding period requirements and age requirements for withdrawal are met.

A traditional IRA is one to which contributions to the account are made with money that has not been taxed yet. A traditional IRA can be an account or an annuity. Contributions and gains in a traditional IRA are taxed upon withdrawal.

When can you open a Roth or traditional IRA?

Both the Roth and traditional IRAs can be opened at any time although the time for making contributions in any year is limited. Contributions for any year can be made during the year or before the due date of the your return, usually April 15, not including extensions for time to file.

How much can you contribute to your Roth or traditional IRA?

If you only make contributions to your Roth or only to your traditional IRA, your contribution limit will be the lesser of:

1. $6,000 ($7,000 if you are age 50 or older)

2. Your taxable compensation

If excess contributions are made to the Roth IRA, a 6% excise tax applies to the excess.

Why consider a Roth conversion?

You may be able to convert amounts from a traditional IRA into a Roth IRA. You may be able to roll over amounts from a qualified retirement plan to a Roth IRA. You may also be able to re-characterize contributions made to one IRA as having been made directly to a different IRA. You can roll amounts over from a designated Roth account or from one Roth IRA to another Roth IRA.

As discussed above, when you make contributions to a Roth IRA, the contributions grow tax free and no taxes upon withdrawal while contributions to a traditional IRA and the subsequent gains from growth are not currently taxed but taxed upon withdrawal. The choice to which IRA account to contribute depends on what your marginal tax rate/bracket is. Since most people will realize growth in wages over their working lives, it is likely that they will be in a higher tax bracket therefore, they would prefer to defer paying taxes on their retirement contributions and pay later on when their income significantly reduces or is fixed like in retirement. (Each individual case is different).

Roth conversions (converting your traditional IRA to a Roth IRA) might be a good idea during retirement because most people will have a significant reduction in their income and therefore might fall in lower tax bracket. This is when it might makes sense to start converting traditional IRA contributions (and pay taxes on both the contributions and gains) to Roth IRA accounts since the taxpayer is now in a lower tax bracket. 

However, everyone’s tax situation is different, and a Roth conversion might not be the best idea. There is another argument for the need to plan for the possibility of future tax increases with the sunset of the Tax Cuts and Jobs Act that was signed into law in 2017. This law sunsets in 2026 and tax rates might go back to the original high rates of up to 40%. This coupled with the increase in the national debt and the need for extra resources to fund government projects, taxes are likely to increase therefore, it is better to pay taxes now by contributing to a Roth IRA in which the contributions made can grow tax free and no taxes upon withdrawal (this is all speculative and a decision can’t be made solely on this assumption). 

Please consult your tax advisor to craft a plan that fits your individual needs.

Ambrose Kizza, MSA, MST, CFE, EA, is an enrolled agent and the owner of Kizza Tax & Accounting, a tax and accounting firm located in Gilford, and specializes in taxation of individuals and businesses and advises business owners on tax strategies that help them achieve real tax savings. Kizza holds a master's in accounting and master's in taxation from Suffolk University in Boston and has been a tax and accounting practitioner for 11 years. He can be reached at ak@kizzaea.com or 603-800-7922.