Even during difficult financial times, opportunity can come knocking at your door. There is very little doubt that the current COVID19 pandemic has wreaked havoc on the U.S. economy, affecting almost every individual in its path. With that said, certain events have made 2020 the year to strongly consider converting any eligible investment accounts into a Roth Individual Retirement Account.
Does a Roth Conversion Make Sense for Retirees?
Under normal circumstances, the conversion of a traditional IRA to a Roth IRA would make little sense for a retiree with other sources of income. They would be required to pay taxes on the conversion amount as they take pretax dollar contributions and convert them into a Roth IRA where contributions are normally taxed upfront with no tax obligation upon withdrawal.
Thanks to the CARES Act, a waiver has been issued for retirees, waving the requirement for them to take mandatory retirement distributions for the year 2020 only. They can use that waiver as an opportunity to convert their normal annual distributions from other IRAs and 401K accounts into Roth IRA contributions without having to pay the taxes normally associated with doing so. That adds up to tax savings on the amount converted based on the individual’s applicable tax rate for 2020.
How High Earners Can Benefit From Roth Conversions
Under normal circumstances, a Roth investment would offer little value to high earners. Anyone making over $139,000, or $206,000 if married and filing jointly would actually not be eligible to benefit from a direct investment in a Roth IRA. This rule also applies to anyone who has no reported income.
However, there are a couple of ways high earners can benefit from a Roth conversion in 2020. First, it’s worth noting that President Donald Trump signed a tax bill in 2017 that slashed U.S. tax rates to its lowest levels in decades. This offers high earners an opportunity to take the tax hit on conversions at 2020 rates, knowing the future income they will earn from their Roth investments will be tax-free when taking distributions during retirement.
The benefit would be realized if tax rates are higher in subsequent years, which is entirely possible if Trump loses the 2020 election. With the country closing in on $27 trillion in National Debt, a new administration would certainly consider increasing tax rates across the board. That would leave 2020 as the last year a high earner could take advantage of current tax rates under this particular scenario.
Second, there is a “trick” high earners can use to get access to a Roth IRA. By law, there are no current income restrictions on contributions someone can make to a traditional IRA. There are also income limits or earnings requirements related to Roth conversions. Strategically, they could invest in a traditional IRA and subsequently convert that amount to a Roth. That would leave them with future earnings that would not be subject to income tax. Investment experts refer to this strategy as a “backdoor” Roth IRA.
As indicated in the opening paragraph, we are living in extraordinary times. As an investor preparing for retirement, it is incumbent on you to stay abreast of opportunities that might arise to give you certain tax advantages.
As Congress contemplates how to keep the U.S. economy from flatlining, there will likely be more favorable tax legislation coming out in the next few months. Under the right circumstances, investment options like Roth IRAs might become more appealing. This is the time to keep your eyes open for good opportunities to take advantage of difficult times.