Roth Conversion Requirements
Since 2010, Roth conversions have been available to anyone with an IRA, without any income limitations. The only requirement is that any taxable amounts from the IRA must be reported in income at the time of conversion; yet in point of fact, being able to recognize the income for tax purposes is the whole point of the strategy in the first place. And unlike just withdrawing the money to attempt to recognize it at favorable tax rates, a Roth conversion allows the individual to report the income and still enjoy tax-free growth in the future.
Roth Conversion Conditions
Notably, though, a Roth conversion is not always a winning proposition. If the individual could have simply withdrawn (or converted) the money in the future at a lower tax rate, more wealth is preserved by not doing a Roth conversion (although there are some other minor benefits to Roth conversions, like avoiding RMDs while alive, changes in tax brackets are by far the most dominating of the four factors that impact Roth conversions). As a result, optimal Roth conversion planning requires making tactical decisions about when to time the recognition of income. In addition, the reality is that a large Roth conversion itself can create enough income to drive up a taxpayer's current rates; as a result, optimal Roth conversion planning often involves an ongoing series of partial Roth conversions, rather than a single large tax event.
Roth Conversion Timing Strategies
Given that the general goal of Roth conversions is to execute them when is income (and tax brackets/marginal tax rates) are lower, general timing strategies for Roth conversions include:
- Years between retirement (end of employment income) and when required minimum distributions must begin
- Years with a job layoff or otherwise temporarily depressed income
- Years where business income (for business owners or the self-employed) is low
- Earlier years of working career before income/earnings have ramped up (though in this circumstance, many just contribute to a Roth account in the first place, rather than converting an existing pre-tax retirement account)
Roth Conversion Key Caveat
The caveat, though, is that if this year is a low-income year, the Roth conversion must be executed by the end of the year. Although taxpayers have as late as their tax filing deadline, plus extensions, to recharacterize a Roth conversion, the original conversion itself must be completed by December 31st to be eligible!
In our next blog post, we will discuss another tax arbitrage tactic - harvesting capital gain (or loss).