A Roth IRA is a unique retirement savings account that allows eligible individuals to set aside money today for a potentially tax-free income stream in the future. Like a traditional IRA, a Roth arrangement allows individuals to make annual contributions of up to $5,500 in 2018, or $6,500 for savers age 50 and older. That is where the similarities between the two arrangements end.
While contributions to traditional IRAs are made with pre-tax dollars, those made to Roth accounts are taxable in the year of the contribution. Conversely, distributions from a traditional IRA taken in retirement are taxable as ordinary income whereas qualified distributions from a Roth IRA may be made tax-free when the account owner is at least 59 ½ years of age and has owned the Roth IRA account for a minimum of five years. In addition, unlike a traditional IRA that requires owners to start taking annual required minimum distributions (RMDs) after they reach age 70 ½, Roth IRAs may remain untouched and allowed to pass to one’s heirs.
This leaves investors with the question of whether they would prefer to pay Uncle Sam up front when they contribute to their accounts or down the road, in retirement, when their withdrawals are taxable.
For many investors, the answer is already determined by the Internal Revenue Code, which limits Roth IRA participation to those individuals whose modified adjusted gross income (MAGI) fall below certain thresholds. For 2018, the ability to make annual Roth IRA contributions is phased out when single-filing taxpayers have MAGI of $135,000, or $199,000 for married couples filing joint returns. However, there is a potential opportunity for high-earning investors to make tax-deductible contributions to traditional IRAs today and later convert the accounts to Roth IRAs to benefit from tax-free and often penalty-free withdrawals before and during retirement.
Before making a Roth conversion, taxpayers must understand that the IRS treats these transactions as taxable events for which account owners may owe tax on some or all of the converted amount. Considering that the recently enacted tax reform act brings individual tax rates to historically low levels in 2018, this may be an ideal year to convert an existing IRA to a Roth IRA. In fact, under tax reform, these lower individual tax brackets will potentially be in effect (and indexed for inflation) through the end of 2025, at which point, they are scheduled to revert to the higher tax brackets that were in effect in 2017.
With these factors in mind, investors should estimate their income tax rates into the future to determine whether the tax implications of a conversion now will outweigh the potential benefits in the future, including tax-free distributions in retirement and the exclusion of Social Security payments from taxable income. Moreover, investors must consider that the decision to make an IRA conversion should not be based solely on taxes; rather it should include a professional assessment of the account owners’ comprehensive estate plan and financial circumstances.
The professionals with Provenance Wealth Advisors assist investors in developing comprehensive estate and retirement plans that help to meet individuals’ particular short-term and long-term needs and goals with an eye on maximizing tax efficiency.
About the Author: Brendan T. Hayes is a financial planner with Provenance Wealth Advisors, an Independent Registered Investment Advisor affiliated with Berkowitz Pollack Brant Advisors and Accountants, and a registered representative with Raymond James Financial Services. He can be reached at the firm’s Boca Raton, Fla., office at (561) 361-2001 or via email at firstname.lastname@example.org.
Provenance Wealth Advisors, 515 E. Las Olas Blvd., Ft. Lauderdale, FL 33301 (954) 712-8888.
Brendan Hayes is a registered representative of and offers securities through Raymond James Financial Services, Inc., Member FINRA/SIPC.
Raymond James is not affiliated with and does not endorse the opinions or services of Berkowitz Pollack Brant Advisors and Accountants. PWA is not a registered broker/dealer and is independent of Raymond James Financial Services. Investment Advisory Services offered through Raymond James Financial Services Advisors, Inc., and Provenance Wealth Advisors.
This material is being provided for information purposes only and is not a complete description, nor is it a recommendation. Any opinions are those of PWA and not necessarily those of Raymond James. You should discuss any tax or legal matters with the appropriate professional. Prior to making an investment decision, please consult with your financial advisor about your individual situation. The information has been obtained from sources considered to be reliable, but Raymond James does not guarantee that the foregoing material is accurate or complete. There is no guarantee that these statements, opinions or forecasts provided herein will prove to be correct. Investing involves risk and you may incur a profit or loss regardless of strategy selected. Investments mentioned may not be suitable for all investors.
Roth IRA owners must be 59½ or older and have held the IRA for five years before tax-free withdrawals are permitted. Additionally, each converted amount may be subject to its own five-year holding period. Converting a traditional IRA into a Roth IRA has tax implications. Investors should consult a tax advisor before deciding to do a conversion.
Please note, changes in tax laws may occur at any time and could have a substantial impact on each person’s situation. While we are familiar with the tax provisions presented herein, as Financial Advisors of RJFS, we are not qualified to render advice on tax or legal matters. You should discuss tax or legal matters with the appropriate professional.