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Limit the amount of taxes paid when planning for retirement!

Most individuals look to mitigate taxation nearing retirement. This is due to the uncertainty of future tax rates as well as future earnings of the individual. Since income is usually high leading up to retirement, it is not uncommon for your adjusted gross income to be high as well. When other forms of income begin to develop, (pension, social security, RMDs) your marginal tax bracket is impacted.

How a Roth IRA can help

All contributions to a Roth IRA account are funded with after-tax dollars, which means there is zero tax on the growth of the account or when funds are withdrawn. Investors must follow these 2 rules in order to avoid the 10% early distribution penalty.

  • 5-year holding period. Funds cannot be withdrawn from the account until 5 years after the conversion takes place.
  • The withdrawal must take place after age 59 ½.

Unlike a traditional IRA, there are no required minimum distributions for Roth IRA accounts. This allows the investor to have greater flexibility with selecting when to withdraw funds in order to maintain a lower marginal tax bracket. Spouse beneficiaries who treat a Roth IRA as their own are also not subject to RMDs during their lifetimes.

There are no income limits for Roth IRA conversions. This allows investors of any level to take advantage of this tax-mitigation technique.


The downside of Roth IRA conversions

Individuals who participate in a Roth IRA conversion are subject to tax on the entire convertible amount for the year conversions were made. If an account is converted all at once, it can cause individuals to be taxed at a much higher rate.


Why Systematic Roth IRA conversions are more effective

If conversions are made strategically, taxation can be controlled and mitigated. By completing the current (lower) marginal tax bracket and postponing the remaining amount for future distributions, investors may pay a lower tax on the entirety of the account.


Now is the time to act!

Roth IRA conversions are inherently more powerful in bear markets. As most portfolios incurred losses in recent quarters, there will be a lower taxation on the convertible amount. Since there is potential substantial growth to be made in the market, now would be an advantageous time to contribute as Roth IRA accounts are subject to zero tax on the growth of the account or when funds are withdrawn.


Details to note

10-year rule: Requires non-spouse IRA & Roth IRA beneficiaries who are not taking life expectancy payments to withdraw the entire balance of the IRA by December 31st on the 10-year anniversary of the owner’s death (If the death occurred in 2020 or later).

Be mindful making Roth conversions close to filing for Medicare and Social Security. These costs are calculated based on the prior 2 years of adjusted gross income. An inflated AGI during these years would result in higher Medicare premiums and increased taxation on your Social Security benefits.

Pay the tax bill with cash from outside the Roth IRA. If funds are removed from the account in order to pay the conversion tax, earning power is limited as compound interest is not allowed to function most effectively.

John Weninger, CFP®

John is a Wealth Advisor within the Family Wealth Management area of the Company. He is the first point of contact for our prospective clients, conducting introductory meetings with clients to discuss their family dynamic and wealth management needs. John assumes the role of the client family’s Chief Financial Officer and coordinates with the client’s current professionals (i.e. attorney, tax accountant, stockbroker, insurance agent) to provide an integrated wealth management plan and investment solution that is custom tailored to meet each client’s specific needs. John began his career at Merrill Lynch as an advisor assistant, serving the needs of families & small business owners. He was the founder of Vision Wealth Partners, a Wisconsin registered investment advisor and has been helping families and small-business owners with financial planning and investment management since 2011. His writing has been featured on CNBC, Yahoo! Finance, U.S. News and John received his Bachelor’s Degree from St. Norbert College majoring in Finance. He earned his Certified Financial Planner (CFP®) in 2017.