ROTH IRA Conversions in the SECURE Act Environment

The passing of the SECURE Act in December 2019 drastically altered some of the assumptions previously used to generate retirement planning strategies. Chief among these strategies was the ‘stretch period’ – the time period in which a beneficiary of a decedent bequeathed IRA is able to draw minimally from the inherited account via the required minimum distribution (RMD) over his or her lifespan. This period was reduced to 10 years under the SECURE Act meaning many beneficiaries now stand to take on additional income tax burdens as larger amounts are drawn out over fewer years. As a result, the strategy of converting a traditional IRA to a ROTH IRA has become a potentially appealing option.

The main benefits of a ROTH IRA include the tax advantages (tax-free growth within the plan as it was funded with post-tax dollars) and no required minimum distributions.

Beneficiaries inheriting ROTH IRAs figure to have a simpler tax situation as well. While the balance is still required to be withdrawn over the 10-year stretch period, the distributions would not be taxable. This is vital for those who may inherit a plan during their peak earning years – the distributions from a traditional plan would increase taxable income during the reduced stretch period and potentially push the beneficiary into a much higher tax rate.

The obvious downside to a ROTH conversion is the tax incurred by the account owner at the time of the conversion. Some choose to take a one-time hit and convert the entire account at once. Others choose to do it piecemeal over a number of lower income years in order to take advantage of lower marginal tax rates.

No matter the method, the ROTH conversion may make sense when taxes on the conversion can be paid with funds outside of the account or the owner will not need to access the account within his or her own lifetime. The conversion would also make sense if the owner expects to be in the same or a higher tax bracket in retirement, or if the funds are intended for heirs whose tax bracket is likely to be at least as high as the account owner’s. A retiree might not want to convert if the money will be left to beneficiaries in lower tax brackets.

Based on the changes under the SECURE Act, as well as the current economic climate, now is the perfect opportunity to revisit your estate plan to evaluate if or when a ROTH conversion makes sense. We here at Wouch Maloney can help you analyze the potential tax impact of such a move to aid in the overall decision-making process.

 

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