If you haven’t considered Roth contributions or conversions before, this year might be the time to consider it. Because of our astronomical national debt, taxes are likely to rise and soon.
For now, the proposed tax plans would only increase taxes on those with incomes over $400,000. However, that limit may be reduced in subsequent years to be much lower, impacting more people.
If you are making more than $400,000, you may want to seriously think about contributing or converting assets into a Roth. If you make less than $400,000, you may still want to seriously consider it. The question is whether you want to choose to pay taxes now or decide to pay them later. While no one knows the future of tax rates, some proactive planning may be in order.
The benefit of the Roth IRA is that once taxes are paid, the investment grows TAX-FREE, as long as you live. Your children can even inherit the Roth tax-free. Also, you never have to take a Required Minimum Distribution (RMD) once you hit age 72 on money within a ROTH IRA. Hands down, this is the best tax protection vehicle available.
If you are making more than $400,000, your marginal income tax rate right now is 32-37% federally. Your income tax rate has a high probability of going up to 39.6%. In addition, your itemized deductions might be capped, making more of your income subject to that higher rate. It is also possible that your payroll taxes for Social Security go up. All of these changes will most likely take effect in 2022, meaning this is the year to realize taxes at a lower rate.
To get more money into a Roth, you only have two options if you make more than $400,000: You can either contribute more to your Roth 401(k) or do a Roth conversion. You can’t make contributions to a regular Roth because you have surpassed the income phaseout limits.
To contribute to your Roth 401(k), you have to change your payroll deductions. If you haven’t been doing this already, you can make the switch now. Just increase your contribution rate to make sure you maximize your 401(k) contribution for the year.
To do a Roth conversion, you must have existing money in a traditional IRA or traditional 401(k). Some 401(k) providers won’t allow you to do this, so check with the 401(k) provider. In a traditional IRA, you can fill out a form to convert money into a Roth. Keep in mind that if you are under age 59 ½, you will need to pay the taxes out of pocket. If you are over age 59 ½, you can have the taxes withheld from the money you convert. Consult with your Private Wealth Manager and your accountant to determine how much you should convert.
The only reason to not contribute or convert into a Roth is if you think you will be in a lower tax bracket shortly. For example, if you are near retirement and your income will drop significantly, you may not want to contribute or convert into a Roth.
If your income isn’t high, Roth conversion can still be a great option. I still worry that tax rates will go up for most people in the future. You just can’t tax the rich enough to pay for all of our national debt. For example, if you are in the 12% tax bracket now (i.e., taxable income below $40,525 for Single or below $81,050 for Married Filing Jointly), likely, you will never be in a lower tax bracket again. You may want to choose to pay 12% now so you can avoid paying a higher rate later, which could quickly go back to 15%, if not higher.
Like all good things, there are restrictions and limitations. If you are considering trying to save yourself future taxes, please consult with your Private Wealth Manager to see if getting more money into a Roth is the right thing for you.
