This article originally appeared on Forbes.com –
Nearly every December, one of the more common questions directed at tax professionals is whether one should convert their pre-tax IRA or 401(k) qualified retirement plan to a Roth IRA or Roth 401(k) plan. There is generally no wrong or right answer, but much of the analysis tends to involve the value of the account being converted and the tax rate the taxpayer would be subject to as a result of the Roth conversion. However, the Presidential Election victory by Donald J. Trump could offer some tax planning opportunities for individuals contemplating a Roth conversion in 2016.
Generally, the main advantage of a Roth IRA over a Traditional IRA is that if you qualify to make contributions, all distributions from the Roth IRA are tax-free so long as the Roth IRA has been opened at least five years and you are over the age of 59 1/2. Furthermore, unlike traditional IRAs, you may contribute to a Roth IRA for as long as you continue to have earned income (for a traditional IRA – one cannot make any contributions after you reach age 70 1/2).
Beginning in 2010, the modified Adjusted Gross Income (“AGI”) and filing status requirements for converting a Traditional IRA to a Roth IRA were eliminated, thus allowing a taxpayer to elect to make a Roth conversion at any time. There are generally some important points to consider when deciding whether to convert a pre-tax retirement account to a Roth.
- Do you have the ability to pay income taxes on the money you convert from your Traditional IRA?
- Based on your income tax bracket, does it make sense to pay the entire tax due in the current year? If you expect your rate to go up, converting may be for you. If you think it will go down, then the opposite holds true.
- Do you anticipate withdrawing Roth IRA funds for personal use within five years of conversion? If so, you may face taxes and penalties if you withdraw within five years of a conversion.
President-elect Trump’s tax plan has received significant amount of attention since his election victory. Even though most of the details are not yet known, a reduction in income taxes across the board, for individuals, businesses and investments are expected. President-elect Trump’s tax rate reductions are not expected to be enacted until at least 2017, but if and when enacted, could potentially offer taxpayers contemplating a Roth conversion with an opportunity to defer taxes on the conversion amount by holding off until at least 2017.
In general, the amount of taxable income on a Roth conversion is based on the fair market value of the IRA assets subject to the conversion. The converted Roth amount is then added to the taxpayer’s gross income on the IRS Form 1040 and is then subject to the applicable tax rates. For example, under 2016 current tax rates, if John had gross income of $45,000 and wishes to convert $50,000 of pre-tax retirement funds to Roth, John would be subject to tax on $95,000 and his tax bracket would have gone from 25% to 28%. Whereas, if John waited until at least 2017 when the Trump tax plan was enacted, and assuming the tax plan rates promoted by President-elect Trump during his campaign were passed, the $95,000 of income would be subject to a tax of 25%. However, with a low tax rate of just 12% for income under $75,000 under the Trump tax plan, John would have the option to do partial Roth conversions over multiple years keeping his annual gross income under $75,000 and taking advantage of the lower tax rate.
The ability to generate tax-free income and gains using a Roth IRA presents many valuable tax-planning opportunities. The election victory of Donald J. Trump and his plan to lower individual income tax rates could make the Roth conversion more tax friendly for taxpayers after 2016.