Thanks to the lower income tax rates in the Tax Cuts and Jobs Act of 2017 (TCJA), the benefits to establishing Roth accounts — contribution and/or conversion — are increasing. If you are concerned about future tax burdens and want to put at least some of your taxes behind you, this is a window of opportunity.

Roth vs Traditional IRA

You have a choice between saving for retirement on a pretax or aftertax basis.  Traditional pretax retirement accounts (IRA, 401(k)) are funded with pretax dollars, which reduces current taxable income.  However, future withdrawals from a traditional IRA are taxed as regular income.  Roth contributions, on the other hand, are not tax deductible.  Instead a Roth allows owners to take distributions during retirement that are tax free, including growth of assets.

Benefits of a Roth IRA

The primary advantage of converting your traditional IRA accounts to Roth IRAs is that the funds will not be subject to income tax upon withdrawal.  Additionally, Roth IRAs are not subject to minimum required distribution (RMD) rules, unlike traditional IRAs which require owners to take taxable withdrawals beginning at age 70 1/2.   With a Roth IRA, you are free to accumulate money for as long as you please.  Moreover, when you take withdrawals, you have no income tax liability as a result.

Roth Conversions: Pay Now to Save Later

The quickest way to get a decent sum into a Roth IRA is by converting a traditional IRA to Roth status.  However, the conversion is treated as a taxable distribution, which will trigger a bigger income tax bill for this year.

Converting a large IRA balance to a Roth could push you into a higher tax bracket.  In this case, it may make sense to convert smaller amounts over several years, thus spreading the extra income from the conversion over multiple tax years instead of all in one year.

How to decide if a Roth is Right

A key driver of whether a Roth conversion makes sense to you is the determination of what your tax rate will be in your retirement years versus today’s rates. If you believe your tax rates during retirement will be the same or higher than today’s rates, a Roth account is often a good option. Conversely, if it is likely that your future tax rate will be lower than today’s rate, a Roth may not be appropriate.

Temporary “Low” Tax Environment Boosts Interest in Roth Conversions

Under TCJA, most individual tax brackets have been reduced slightly. However, the bill includes a “sunset” provision that all individual tax changes will lapse after 2025, which could lead to higher tax rates. With the changing political climate in Washington, we may never see federal tax rates this low again.

Talk to a Professional

Roth accounts are undeniably complex. There are many rules and considerations related to Roth IRA, Roth 401(k), and 403(b) eligibility, transfer, rollover, distribution and conversion rules.  A trusted advisor can help assess the factors to consider such as your current income, marginal tax bracket, and outlook for future tax obligations.

The ultimate goal is to create flexibility and manage taxes in retirement through a nice mix of taxable, tax-free, and tax deferred accounts.  Please contact your Signet advisor to discuss.     If it makes sense, talk to your tax adviser before pulling the trigger on a conversion — just to make sure you’ve considered all the relevant factors.

With the potential for higher tax rates starting in tax year 2026 and beyond, individuals should consider funding and/or converting to Roth accounts (IRA and/or 401(k)).  In a lower tax environment, it may be beneficial to shift some assets to a Roth account to create a tax-free account for retirement.