One strategy that may make sense for many of your clients in light of the SECURE Act is a Roth conversion. In addition to the overall low tax rate environment created by the tax reform legislation passed at the end of 2017, several aspects of the Act lend themselves well to Roth conversions.
Delayed Required Minimum Distributions (RMDs)
The SECURE Act delayed the commencement of RMDs for those who reached age 70½ on or after January 1, 2020. For some of your clients, this could mean as much as two extra years until they have to begin their RMDs from their IRAs or other retirement accounts. Those who won’t need the funds from their RMDs might consider doing a Roth conversion each year to reduce the account balance subject to RMDs when they reach age 72.
Depending upon the client’s situation, the amount of the conversion can be managed each year to keep them in their current tax bracket. Their anticipated tax bracket in retirement versus their current bracket is a key planning consideration. You will want to be sure that your client can pay any taxes with money held outside of the traditional IRA or other retirement account.
The money converted to a Roth provides a level of tax diversification in retirement as a hedge against any future changes in the tax laws or other rules.
Changes to Inherited IRA Distribution Rules
Changes to the distribution rules for non-spousal beneficiaries of inherited IRAs contained in the SECURE Act are a very solid reason for some clients to consider a Roth conversion.
The SECURE Act effectively eliminated the stretch IRA for these beneficiaries. For new inherited IRAs beginning on January 1, 2020, the non-spousal beneficiary generally must withdraw the full amount of the IRA within 10 years. There are several exceptions to this rule that remain in place for non-spousal beneficiaries who are:
- Minors, until they reach the age of majority (or age 26 if they are in school)
- Disabled or chronically ill
- Less than 10 years younger than the IRA owner
This change can upset estate planning for clients as it relates to these accounts. In some cases, the 10-year withdrawal time limit can result in large tax bills for beneficiaries, eroding a large chunk of the account value they had intended to pass on to their heirs.
Converting some or all of their IRA account to a Roth IRA during their lifetime can be an effective planning alternative. While clients will need to pay taxes on the amount converted, the Roth IRA can result in significant tax savings for their heirs. While the account will still need to be fully withdrawn within 10 years, these withdrawals will be tax-free to their heirs.
This conversion decision should be made in the context of the family’s overall tax situation, the relative ages of the IRA account holder to their beneficiaries and other factors. For heirs who might be in their prime earning years when they inherit the account, the taxes from distributions connected to a traditional IRA on top of their own earnings can be quite steep.
When doing a Roth conversion from a traditional IRA or other retirement account, it’s important for those who must take an RMD for that year to take the distribution first, then do the Roth conversion.
The Roth conversion remains an important planning tool under the SECURE Act. Your clients will need your expert guidance to ensure they are using this tool correctly and that it is the best option to accomplish their goals.