This is the latest installment in our series on how to learn how you can benefit from with the financial and economic fallout from the coronavirus pandemic. This series is designed to keep our clients and radio listeners informed on the latest financial strategies to counter the virus’ economic impact and turn typical obstacles, such as higher taxes in the future, into opportunities that provide a tax-free savings and tax-free lifetime retirement income. Timing is the key element in seizing these opportunities.

The economic devastation caused by the coronavirus has been wreaking havoc with the stock market. Right now might not seem like a great time to be an investor of any sort. However, there’s one potentially strategic move that you can make right now – converting a traditional IRA into a Roth IRA. Please note, a Roth conversion is not ideal for everyone and there other Roth-like strategies that could be superior in certain client’s cases. Timing is crucial in analyzing tax reducing solutions right now, while we still have a pro low-tax president such as Donald Trump in office and before a pro high-tax president makes their way into the White House.

A key advantage to a Roth IRA is that you can take money from your Roth IRA tax-free! Traditional IRAs require a tax when you withdrawal money and the government forces you to take annual Required Minimum Distributions, known as RMDs (whether you need the money or not) beginning at age 72 (for those that didn’t turn 70.5 before 2020). There are no RMDs for a Roth IRA.

A Roth IRA features tax-free growth and tax-free withdrawals during retirement. However, it differs from a traditional IRA in several ways other than just saving taxes on your income. A Roth IRAs’ income doesn’t count towards taxing your Social Security, increasing your reportable taxable income (which can raise your Medicare premiums) or forcing you into a higher marginal tax bracket. We find the average retiree couple is giving up $3,000 to as much as $24,000 (or more) by not getting these strategies implemented into their comprehensive retirement plan. Many retirees have shared with me that they thought it was too late. If you are concerned about the risk of reducing your retirement lifestyle or, if you’re a Baby Boomer trying to navigate into retirement, there may not be a better opportunity for timing and shifting for major tax savings.

The tax rules allow you to have both a traditional IRA and a Roth IRA. This allows you to take money from each account depending on your tax situation. This flexibility allows you to spend money from your traditional IRA as long as the withdrawals keep you in the lowest available tax bracket, which prevents higher tax exposure down the road. If you want to or need to spend more, you can take the extra cash from your Roth IRA. This gives you the extra cash without pushing you into a higher income tax bracket.

If you already have a traditional IRA or other tax-deferred investment plan, you can switch to a Roth but there’s a catch – you’ll have to pay income tax on the account balance in the same year that you make the conversion. While there’s never a good time to have a bigger tax bill, the strategy could actually be favorable this year. If you do a Roth conversion when the market is down, your account is worth less, making your tax bill smaller because you had a smaller conversion amount. You would want to have your money recover in a tax-free growth and tax-free income vehicle as opposed to recovering your account value in a tax-deferred and taxable-on-distribution account. Recovering your account value in a tax-deferred account would also result in growing higher taxes.

For example, if you had a traditional IRA that was worth $250,000 on January 1st and you’re in a 25% tax bracket, a January 1st Roth conversion would have cost you $62,500 in federal taxes. If your account lost twenty five percent of its value in March of 2020 ($250,000 x .75 = $187,500) and you did a Roth conversion after the loss, you’d be converting $187,500, making your tax bill only $46,875. $46,875 – $62,500 = $15,625.00 of reduced Roth conversion tax! If your tax bracket is higher, the conversion tax savings will be even greater. The last thing you would want to do is Roth convert on your highest balance. This would result in you paying a higher Roth conversion tax bill. I want to remind you that taxes have not been this low for years. Taxes are going to be forced higher with the already $2 trillion Coronavirus Aid, Relief and Economic Security (CARES) Act. If your income is going to be reduced this year then the timing of this strategy will cause even less conversion tax to be due.

Learn the CARES Act guidelines as not everyone qualifies. The present ruling allows a penalty-free withdrawal from your IRA this year if you are 59.5 years of age or less. This provision allows a penalty-free withdrawal and/or enables the withdrawal to be paid or returned to a qualified account over a three year period, without taxes.

If you are a certain number of years away from retirement or already in retirement, you can control your tax risk to avoid the all but certain higher taxes that are coming. You can do this by converting to a Roth IRA or doing a partial Roth conversion, taking advantage of currently low account balances and lower tax rates. A Roth conversion could be a timely strategy that provides you with more income in retirement that is also tax-free. This strategy prevents additional taxes that are triggered by staying in the traditional IRA Tax Trap. The strategy also allows you to leave money to your family, tax-free!

Charles Oliver
Wealth Strategist | Best-Selling Author
We help Baby Boomers and Retirees thrive in retirement through a clear retirement road map that provides market correction and tax protection to optimize income and assets!