Q. Can a Roth conversion affect the taxation of long-term capital gains?
A. Yes, and could be significantly if you are not careful!
That’s because Roth conversion income, like all other ordinary income, reduces the benefit of the LTCG rates, increasing the overall tax cost of the conversion. This interplay can easily throw off even the best tax projections, especially when they rely on the low (or even 0%) LTCG rates stated in the Tax Code. When there is additional ordinary income, like Roth conversion income, those favorable tax brackets are not as attractive as they appear to be.
What's worse, Roth conversions cannot be undone anymore — the tax law changes eliminated recharacterization of Roth IRA conversions beginning in 2018 — one should be careful to do an accurate projection of the tax effect of a Roth conversion. But the permanency of a Roth conversion does not mean it should be avoided. Roth IRAs still offer long-term tax benefits — mainly tax-free growth and no lifetime required minimum distributions for Roth IRA owners, allowing more tax-free accumulation and a hedge against future tax increases.
In fact, if IRA funds are not converted, eventually those IRA funds will be subject to RMDs and those RMDs will similarly cause an increase in capital gains taxes — and at possibly higher future tax rates. That’s why Roth conversions should still be seriously considered while today’s tax rates are at historic lows. However, the tax cost of the conversion needs to be more accurately projected since the tax due cannot be reversed.
In next blogpost, we will discuss some other so-called stealth taxes triggered when income is increased by actions such as a Roth conversion.
A. Yes, and could be significantly if you are not careful!
That’s because Roth conversion income, like all other ordinary income, reduces the benefit of the LTCG rates, increasing the overall tax cost of the conversion. This interplay can easily throw off even the best tax projections, especially when they rely on the low (or even 0%) LTCG rates stated in the Tax Code. When there is additional ordinary income, like Roth conversion income, those favorable tax brackets are not as attractive as they appear to be.
What's worse, Roth conversions cannot be undone anymore — the tax law changes eliminated recharacterization of Roth IRA conversions beginning in 2018 — one should be careful to do an accurate projection of the tax effect of a Roth conversion. But the permanency of a Roth conversion does not mean it should be avoided. Roth IRAs still offer long-term tax benefits — mainly tax-free growth and no lifetime required minimum distributions for Roth IRA owners, allowing more tax-free accumulation and a hedge against future tax increases.
In fact, if IRA funds are not converted, eventually those IRA funds will be subject to RMDs and those RMDs will similarly cause an increase in capital gains taxes — and at possibly higher future tax rates. That’s why Roth conversions should still be seriously considered while today’s tax rates are at historic lows. However, the tax cost of the conversion needs to be more accurately projected since the tax due cannot be reversed.
In next blogpost, we will discuss some other so-called stealth taxes triggered when income is increased by actions such as a Roth conversion.
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