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

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.”

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.