With a Roth IRA, contributions are made after tax, meaning you’re paying taxes now rather than on withdrawals in retirement. This account can be attractive to those who predict they’ll be taxed at a higher rate in retirement; they may consider paying taxes on the contributions now at a lower rate.
Other investors are considering a Roth conversion because of expected changes to the federal estate tax, according to CNBC. Currently, the 40-percent federal tax rate applies to estates over $11.7 million (or $23.4 for a married couple). A proposal seeks to lower the threshold for that tax rate to $3.5 million.
That’s significant in the context of retirement savings. A Roth conversion shrinks the size of an estate by the amount of income tax paid on that conversion.
Wealthy individuals can therefore use a Roth account to reduce the size of their taxable estate and potentially avoid federal estate tax, said Certified Financial Planner Leon LaBrecque. A similar concept applies in states that levy an estate tax.
[Related content: Considering a Roth Conversion? What to Know]
Should you consider a Roth conversion now?
You shouldn’t rush to convert your IRA based on the single factor of potentially higher taxes, warn some financial advisors in a recent MarketWatch article.
There are a few questions an investor should ask himself, said Brian Schmehil, a certified financial planner and director of wealth management at The Mather Group, including: will the amount I’m converting be taxed at a lower rate now than it could be in the future, and do I have money outside of these accounts I can use to pay the tax liability so that the assets can continue to grow as if I hadn’t paid tax for the conversion?
That’s not to say many investors couldn’t benefit from the potential advantages of a Roth IRA.
“Converting IRAs to Roth IRAs should be something everyone should consider regardless of President Biden’s plan or any other president’s plan,” said Certified Financial Planner Scot Hanson in MarketWatch.
One other factor to consider: a Roth conversion increases your taxable income in the year you complete the conversion, which could potentially put you into a higher tax bracket.
[Related: What is a Backdoor Roth IRA?]
Financial professionals added they would wait for the final legislation before making any recommendations about conversions related to future tax increases. If you’re weighing the pros and cons of a conversion, consult with your tax or financial professional to decide what’s right for you.
If you’re considering moving forward with a Roth conversion, talk to one of our IRA counselors for more details on how the process works, as well as the benefits of a self-directed Roth IRA.
Learn more about a Roth conversion: Start a conversation with us today