To Roth or Not to Roth
That is the question. And in order to answer the question effectively, one must assess both current and future potential tax situations.
Taxes are one of very few certainties in life, and they are top of mind this time of year. Usually, we try to delay paying taxes as long as possible. But that’s not necessarily the best move if your income tax rate is lower now than it is likely to be in the future. In this situation, funding Roth retirement accounts might be a good strategy. For a quick tax treatment refresher, pre-tax retirement accounts are funded through contributions which lower current income and future distributions are taxable as ordinary income. Roth retirement accounts, on the other hand, are funded with after-tax dollars, offering no current tax benefit, but future qualified distributions are not taxed as income.
In evaluating whether to Roth or not, it is helpful to evaluate when you might take distributions, and how different your income and tax situation might be at that time. Will your income be lower in retirement than it is now? Are you planning to retire in a state with lower, or no income tax? If the answer is yes to these questions, you may want to stick with pre-tax retirement accounts for now. On the other hand, if your income will be lower than usual this year, then it might be a good year to maximize Roth contributions.
Regardless of your current situation, it is also important to acknowledge that tax laws can change. Consider whether it is likely that Congress either raises income tax rates, or reduces or eliminates the income tax advantage of funding Roth retirement accounts. To help pay for pandemic related stimulus and other costly government programs, it seems more than likely that tax rates will increase. However, it is less likely that members of Congress will take action on existing Roth accounts.
If you put some thought into the decision and want to shift more assets into Roth accounts, you have a few options. First, if you are eligible based on your earned income, you can fund a Roth IRA (2022 maximum contribution of $6,000 or $7,000, if you are 50 years of age or older). Single taxpayers may contribute to a Roth IRA if their modified adjusted gross income (MAGI) is $144,000 or less. Married taxpayers must have a MAGI of less than $214,000 in 2022. Second, you may be able to make Roth 401k contributions if this is an option in your employer-sponsored retirement plan (2022 maximum of $20,500 or $27,000 if you are 50 years of age or older). Note that shifting existing contributions from pre-tax to Roth will result in a reduction in your net pay. Best practice is to model your current paycheck versus one with greater after-tax contributions and potentially easing into this change over time. Third, you can do a Roth conversion transferring funds from a pre-tax IRA into a Roth IRA, paying the tax at the time of the transfer (preferably with non-retirement assets). There are some important considerations here, including maintaining assets in qualified retirement plans, which are not included in the calculation of tax on the conversion, that you need to consider. But by doing some initial tax and financial planning, you should be able to make rolling Roth conversions over time, without crossing into the next tax bracket. If you are over age 72, you must take any required minimum distributions before doing a Roth conversion and you must complete the process before the close of the calendar year.
These are just a few of the considerations around Roth retirement assets. If you wonder whether you have the best mix of pre-tax and Roth retirement assets, and want to discuss options for building your Roth portfolio, please give us a call and we can go over the specifics of your situation.
Read the Financial Planning Focus May 2022:
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