What You Need to Know
- Perhaps even more so than in other years, year-end Roth planning is a key issue for many of your clients in 2021.
- The proposed elimination of the backdoor and mega backdoor Roth creates additional year-end planning issues this year.
- The key planning issue is whether a Roth account is the right option for your client.
As we near the end of 2021, there are a number of year-end planning issues surrounding Roth IRAs that could affect your clients. Beyond normal issues like whether or not to do a conversion, proposed legislation potentially limiting strategies like the backdoor and mega backdoor Roth could affect the advice you provide to clients regarding these strategies.
Roth IRA conversions are a year-end planning issue to consider in most years. As part of your year-end tax planning with your client, you will want to look at where they stand taxwise. Will their income be lower than normal? Do they have room left within their current tax bracket that they might fill up with the income generated by the conversion?
Meanwhile, legislation including the sweeping 2017 tax overhaul, coronavirus relief measures and the Democrats’ proposed tax plan has created new year-end planning issues. Assess your client’s situation and consider these timely planning opportunities, some of which will end soon.
1. Taking Advantage of Low Tax Rates
While there are proposals to raise rates for some taxpayers, rates for 2021 remain historically low as part of the Tax Cut and Jobs Act that became effective for the 2018 tax year. This can make a Roth IRA conversion more economical for your client this year than might be the case in future years.
If your client expects to make in excess of $400,000 in future years, 2021 might represent their best chance to do the conversion while they are in a relatively low tax bracket.
2. Making a Large Charitable Contribution to Offset Taxes
The higher limits for charitable deductions enacted under the Coronavirus Aid, Relief and Economic Security (CARES) Act in 2020 remain in place for 2021. Under these rules, taxpayers can deduct charitable contributions up to 100% of their adjusted gross income for the year.
For clients who are charitably inclined and who want to take advantage of these higher deduction limits, this can be a great opportunity to do so. With the solid gains in the stock market over the past several years, your clients may have appreciated securities that can be an excellent vehicle for making charitable donations. Beyond the charitable deduction, gifting appreciated securities removes any tax liability for capital gains that would be there if they were sold.
These higher charitable deductions can be used to offset some or all of the taxes that would be due on a Roth IRA conversion. If doing a Roth conversion is a planning priority for your client and they have the ability to make a significant charitable contribution, then shielding some or all of the tax hit from the conversion with these contributions makes a lot of sense.
3. Paying Taxes for the Next Generation
Since the Setting Up Every Community for Retirement Enhancement (Secure) Act mandated that inherited IRAs for most non-spousal beneficiaries must be fully depleted within 10 years of inheriting the account, Roth IRAs have become a viable estate planning tool.
While inherited Roth IRAs are subject to this 10-year rule, if the original account holder had satisfied the five-year rule prior to their death, then the beneficiaries will not be required to pay taxes on distributions from the inherited Roth IRA.