A Roth IRA is an individual retirement account which allows you to set aside after-tax income up to a specified amount each year, where both earnings on the account and withdrawals after age 59 ½ are tax-free. The use of a Roth account can also be leveraged as a tax-efficient estate planning strategy.
Traditional Vs. Roth
IRAs Funds in a traditional qualified plan or IRA are tax-deferred assets. Taxes are paid to the IRS when distributions are made (except in the case of certain charitable donations). Assets in Roth accounts, on the other hand, are after-tax contributions. Perhaps most importantly, any asset appreciation inside a Roth account will entirely escape tax as long as the five-year holding period is met.
A Roth conversion involves pre-paying the tax on the account. The cost of moving money from a traditional IRA into a Roth allows you to pay taxes due on the IRA assets, and then enjoy the benefits of the Roth IRA account. When viewed as a family wealth planning technique, it’s a way for the parent(s) to leave a more valuable asset to heirs or to create a tax-free fund for the account owners themselves to use in other financial planning or emergencies.
Roth conversions can be an integral part of multi-year tax planning. The amount to be converted can be based on how much additional taxable income would have to be reported before a higher bracket would apply. The tax itself, if at all possible, should be paid from funds other than those to be converted.
If the tax is paid from a taxable account, the full amount of the qualified plan or IRA distribution can be moved into the Roth account.
Considering A Roth Conversion—Why Now?
There are a few reasons a year-end Roth conversion may be advantageous for you, depending on your individual circumstances. Before exploring the benefit, it’s important to know that an inherited IRA cannot be converted to a Roth. The IRA has to be converted to a Roth during the owner’s (or, possibly the owner’s spouse’s) lifetime or the opportunity is lost.
A Roth conversion involves a pre-payment of tax. The impact of the tax can be mitigated by paying the tax while the account owner is in a lower bracket, or by offsetting the additional income with some itemized deductions such as charitable contributions (perhaps to a Donor Advised Fund) or medical expenses. Paying taxes now, or at current rates, acts as a hedge against future tax rate increases.
As year-end draws closer, now is a more realistic and appropriate time to project tax brackets and estimate how much additional income could be added before moving to the next higher bracket—and we can help.
Legacy Planning & RMDs
A Required Minimum Distribution (RMD) is an IRS-mandated amount of money you must withdraw from a Traditional IRA or qualified employer-sponsored retirement plan each year. If you have, or are anticipating, an RMD amount which exceeds your current spending needs to support your lifestyle, recharacterizing to a Roth IRA offers an advantageous legacy planning strategy while helping reduce your RMDs.
Recharacterizing your retirement account requires careful consideration based on your individual circumstances. We can help you assess your needs and take action accordingly in a timely and thoughtful manner.
- December 31, 2023: The date by which a Roth conversion for 2023 would have to be completed.
- April 15, 2024: Date for most taxpayers to pay the tax due on a Roth conversion.
Working With Janney
Depending on your financial needs and personal preferences, you may opt to engage in a brokerage relationship, an advisory relationship or a combination of both. Each time you open an account, we will make recommendations on which type of relationship is in your best interest based on the information you provide when you complete or update your client profile.
When you engage in an advisory relationship, you will pay an asset-based fee which encompasses, among other things, a defined investment strategy, ongoing monitoring, and performance reporting. Your Financial Advisor will serve in a fiduciary capacity for your advisory accounts.
For more information about Janney, please see Janney’s Relationship Summary (Form CRS) on www.janney.com/crs which details all material facts about the scope and terms of our relationship with you and any potential conflicts of interest.
By establishing a relationship with us, we can build a tailored financial plan and make recommendations about solutions that are aligned with your best interest and unique needs, goals, and preferences.
Contact us today to discuss how we can put a plan in place designed to help you reach your financial goals.
Janney Montgomery Scott LLC, its affiliates, and its employees are not in the business of providing tax, regulatory, accounting, or legal advice. These materials and any tax-related statements are not intended or written to be used, and cannot be used or relied upon, by any taxpayer for the purpose of avoiding tax penalties. Any such taxpayer should seek advice based on the taxpayer’s particular circumstances from an independent tax advisor.