Tuesday, September 15, 2020
The difference between a traditional IRA and a Roth IRA is that traditional IRAs "get a tax deduction when you contribute but pay taxes when you take it out." Roth IRAs get no tax deduction when contributions are made, but grows tax-free.
It is important to discuss all relevant factors when advising clients to move to Roth IRAs.
There are seven situations to consider for each client when providing advice on this issue.
- Is the Roth pot of money small compared to the taxable and tax-deferred pots?
- Is the current marginal tax-bracket low? This could be the case if the client retired before taking Social Security or RMDs, or if they are starting a pass-through business (LLC or Sub-S) with very little income or even losses.
- Will the client have high income in retirement, such as pension income?
- Will the RMDs be burdensome if the client doesn’t convert some money to the Roth?
- Does the client have any after-tax money in their tax-deferred accounts and, if all IRAs are converted, will that allow for future backdoor Roth contributions?
- Will the client benefit from a possible state income tax-exemption for amounts converted?
- Are there some estate planning benefits from conversions?
See Allan Roth, The Seven Cases to do a Roth Conversion, Advisor Perspectives, September 14, 2020.
Special thanks to Jim Hillhouse (Professional Legal Marketing (PLM, Inc.)) for bringing this article to my attention.