Roth Conversion Considerations
Defer, defer, defer… right? This is the common approach to handling taxation. Sure, it helps your current taxation, but is it always the best choice? Without adequate analysis, this decision can be compared to skipping a workout. You forego the jog today only to realize it is a much more cumbersome task to pick back up running next week. Unfortunately, with taxes, if you don’t exercise today, you could face a marathon in the future.
Tax deferral can be achieved in different ways. The most common situation is to save in a company retirement plan or a personally owned traditional IRA. These techniques are most opportune if you are in your highest-earning years and expect future tax rates to decrease. Now ask yourself, is that true for you?
We often see that people will save a lot of money over a long period in their company retirement plan. These contributions grow over long periods and typically amount to a substantial amount in retirement. Once retirees withdraw money to live on in retirement, they then pay the income tax and can often be in a higher tax bracket than during their working years. That’s right, they retire and might get a pay raise. This can become damaging if one is pushed into a higher tax bracket because of their new “raise”. Consider the effect of jumping from the 24% to the 32% tax bracket. That 8% additional tax hit could be avoided with early planning. People mustn’t only factor their current paychecks as income but remember that they have an inflating bucket of past paychecks waiting to be received.
Today, the S&P 500 index is down 18.14% year-to-date. An account balance of $100,000 invested in this index is now worth roughly $81,860. Which account value would you rather pay taxes on? Let me remind you that the account value could experience significant increases in value over future decades. Would you prefer that future pot of money to be taxable or tax-free?
I am a fan of traditional retirement accounts to defer taxes and Roth retirement accounts to pay taxes now, then never pay again. We believe a properly designed retirement plan often involves using both account types. We are frequently asked if the Roth is “better” than the traditional retirement accounts. The answer is that it depends. There is a “better” time to apply each and there are many strategic tax opportunities by using both account types to recognize taxes at the most impactful times.
If you expect your income to rise, expect tax rates to increase, and feel your investment account values will increase between now and retirement, you might want to review the possibility of a Roth conversion. Regardless of your opinion, it is never too early to start building various tax buckets. Contact Sound Wealth Management if you’d like help exploring your personal opportunities.
