What is a “Roth conversion”?

What is a “Roth conversion”?

A “Roth conversion” is the action of converting pre-tax retirement assets (401(k), IRA, etc…) into Roth IRA assets. The converted assets are typically considered taxable income for the year of the conversion.

Why consider a conversion?

Your taxable income (and marginal tax bracket) is temporarily depressed, and you’d like to take advantage of the lower effective tax rate.

Tax rates may be higher in the future. 

  • Under the 2017 Tax Cuts and Jobs Act (TCJA), the highest Federal income tax rate is currently 37%. This is set to revert back to 39.6% January 1, 2026.
  • For high earners, the net investment income tax (NIIT), also known as the Medicare surtax, is currently 3.8%, and the income thresholds for this tax are not indexed for inflation.
  • Your Medicare insurance premium is based on your taxable income (including tax-free interest), which includes taxable distributions from your retirement accounts. Qualified Roth IRA distributions are not taxable and have no bearing on your Medicare premium costs.

You don’t want your beneficiaries to pay income taxes on the required minimum distributions (RMDs).

  • The SECURE Act, if passed, may require certain non-spouse beneficiaries to distribute 100% of an inherited IRA within a shorter time period (5-10 years) instead of over their lifetime.

What are other methods for funding a Roth IRA?

Like a Traditional IRA, you may make annual contributions as long as you have sufficient earned income (and don’t earn too much!). The maximum contribution for the 2019 tax year is $6,000 ($7,000 if you are turning 50 or older during the year).

If your adjusted gross income is too high, you won’t be able to fund a Roth IRA directly. The 2019 income phase-out levels follow:

  • Single Filer: $122,000 – $137,000
  • Married Filing Jointly: $193,000 – $203,000

The “Back Door” IRA conversion is an indirect method for funding a Roth IRA. This method requires funding a non-deductible IRA and converting these assets to a Roth IRA. The “pro-rata” rule may apply if you have other IRA assets so please review this method thoroughly with a tax professional before proceeding.

Please call us if you’re considering a Roth conversion or would like to discuss the merits of a conversion given your unique circumstances.

All the best,

Your Team at Gamble Jones