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Retirement Planning > Saving for Retirement > IRAs

Ed Slott: Inflation Has Created an Unprecedented 4-Year Roth Conversion Opportunity

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Due to high inflation, a large expansion of the tax brackets will occur in 2023, so advisors need to counsel their clients to consider a four-year Roth IRA conversion plan now since the tax rates are the lowest “most people will see in their lifetimes,” according to Ed Slott of Ed Slott and Co.

“The key planning point for a Roth conversion is to pay the taxes when rates are the lowest,” Slott told ThinkAdvisor Wednesday in an email. “It’s all about the tax rates, and how much Roth conversion income can be pushed into the lowest tax brackets. This opportunity is available now.”

Planning for year-end, Slott relayed, “might require planning for this year and next year at the same time, especially when it comes to evaluating a Roth conversion.”

In fact, Slott said, advisors “might want to look at a four-year Roth conversion plan” for their clients.

While there’s no deadline for doing a Roth conversion, “if you want it to count for this year (2022) then the funds must leave the IRA before year-end,” Slott said.

The 2017 tax overhaul reduced tax rates through 2025, Slott explained, “but they go back to those pre-law levels in 2026; if the law doesn’t change, Roth conversions will be more expensive, tax wise, after 2025.”

Tax brackets expand each year based on cost-of-living adjustments tied to inflation, Slott continued, “but the expansion for 2023 is off the charts.”

Advisors will “want to show clients that they can plan out Roth conversions for both this year and next year at the same time,” Slott said. “This could also be the case for 2024 and 2025, but we don’t have those tax rate brackets yet.”

If advisors believe their clients’ tax rates will be higher in the future than they are now, “then the Roth conversion is a good bet and should be taken advantage of before rates increase,” Slott advised. “If the tax laws don’t change, rates are scheduled to increase automatically after 2025, so counting this year, there may only be four years left to push Roth conversion into lower tax brackets.”

Chart: Projecting the Tax on a 2022 vs. 2023 Roth IRA Conversion

How Inflation Affects Tax Brackets

Looking ahead to next year for tax planning is more important this year than in prior years due to the large inflation adjustment, Slott explains.

When it comes to taxes, inflation helps clients actually save money.

For instance, a married couple filing jointly in 2022 can earn up to $340,100 of taxable income and still remain in the 24% tax bracket, Slott said.

“But in 2023, thanks to the large inflation increase, that 24% bracket expands by a record-breaking $24,100 allowing up to $364,200 of taxable income for the 24% bracket,” Slott said. “A higher income client could include an additional $45,900 of income before reaching the top 37% bracket.”

While it’s unclear how inflation will affect the two remaining years — 2024 and 2025 — before tax rates are scheduled to increase in 2026, “the tax brackets will still expand some, as they always do for those years as well,” Slott said.

Advisors will “probably want to work with clients on a four-year Roth conversion plan (2022-2025) to take advantage of paying low taxes on Roth conversions for each of those years.

Who Should Do a Roth IRA Conversion?

A four-year Roth conversion strategy, Slott continued, would be ideal for clients 68 or younger.

“Even beginning at age 68, in 4 years (ages 68, 69, 70 and 71) substantial funds may be removed from the IRA through Roth conversions, before reaching age 72 when RMDs (required minimum distributions) will begin. That can result in a dramatic decrease in taxes when the client begins RMDs since they will be lower. If everything is converted by then, there won’t be any RMDs, resulting in lower taxes for the rest of the clients’ life, depending of course on other income,” Slott explained.

RMDs and Roth Conversions

Once clients are already taking RMDs from their IRAs, those RMDs cannot be converted.

“RMDs are never eligible to be converted to Roth IRAs,” Slott said. “But once the annual RMD amount is satisfied, then any or all of the remaining IRA balance can be converted for that year.”

However, ”the conversion will effectively still cost more since tax had to be paid on the RMD amount which cannot be converted. That’s why it’s more tax efficient for most clients to get conversions done before RMDs begin.”

Secure Act 2.0

Among the tax proposals being negotiated now in Congress is the sweeping retirement package, Secure Act 2.0, which will likely include a provision to raise the RMD age to 73, 74 or maybe even 75.

If passed during the lame-duck session of Congress, such a change “would expand this window of Roth conversion opportunity,” Slott said.

Have the Roth Talk Before Year-End

Slott said the four-year Roth conversion plan “would be a high-value conversation to have now, before year-end with every client who has an IRA.”

While not every client should convert, advisors “should bring this tax planning opportunity to each client’s attention,” Slott advised. “In addition, advisors should get input from the clients’ CPAs or other tax preparers who may have a good estimate of their 2022 income level by now for a more accurate tax projection.”

One More Roth Conversion Year-End Tip

“If you have a married couple client, where one spouse has died this year, it would be especially smart to not use the 4-year plan, but instead push as much Roth conversion into this year to take advantage of the lower married-joint tax rates on this final joint tax return for 2022,” Slott said.

After this year, Slott continued, “that surviving spouse will likely be filing as a single person and paying taxes at higher rates, even with inflation adjustments. A year-end 2022 Roth conversion can save that widow(er) a ton in taxes for the rest of their lives.”


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