TAX ADVISOR

Daniel F . Rahill

Despite shifting political winds , Roth IRA conversions currently still offer high-income clients ways to protect retirement money .

INCE ROTH IRAS FIRST CAME INTO BEING , TAXPAYERS HAVE been able to establish these accounts directly through contributions or by converting their traditional IRAs . Initially , these options were unavailable to higher-income individuals , as eligibility for direct contributions and conversions was limited by a taxpayer ' s modified adjusted gross income ( MAGI ). For example , in 2024 , a married couple filing jointly cannot make a direct Roth contribution if that income exceeds $ 240,000 .

But then the Tax Increase Prevention and Reconciliation Act of 2005 repealed the limitations on conversions for the wealthy , a change effective for the tax years beginning after 2009 . As a result , Roth conversions became accessible to all taxpayers , regardless of income level , increasing their popularity and establishing them as a staple of financial planning .

Initially , taxpayers could undo the Roth IRA and change it back into a traditional IRA within a certain period . This option was reassuring , especially when the value of a converted Roth IRA had decreased . However , the Tax Cuts and Jobs Act of 2017 took away this ability to recharacterize , a change that reflected shifting governmental attitudes toward IRAs . Now , once an IRA is converted to a Roth , it cannot be undone .

There were shifts in political attitudes yet again in 2019 . That year , the Setting Every Community Up for Retirement Enhancement ( SECURE ) Act was signed . The law now requires most non-spousal inherited IRAs to distribute the entire account within 10 years , replacing the previous rule allowing distributions over the beneficiary ' s lifetime . This change significantly affected the previous assumptions driving IRA and Roth IRA conversions .

This new limitation on payouts has made Roths more attractive , because even as distributions from an inherited traditional IRA lead to taxable ordinary income over the 10-year period , a Roth IRA investment can grow taxfree until the end of the 10 years , at which point a fully tax-free distribution is made . This makes the Roth IRA a powerful estate planning tool for retirees with sufficient other assets to live on , allowing them to defer their distributions for the full 10 years .

Another advantage of these vehicles is that Roth IRAs or 401 ( k ) s have no required minimum distribution requirement . Traditional IRAs do , and in 2024 those distributions must start when the account holder is 73 . The Roth balance , meanwhile , can continue growing tax-free throughout a person ’ s retirement .

It should be noted that there is a distribution limitation specific to Roth IRAs : the five-year rule . It says you must wait at least five years after your first contribution to a Roth IRA before you can withdraw earnings tax-free . This rule applies to all Roth IRAs , including inherited accounts and those converted from traditional IRAs .

The Backdoor Roth IRA

Those whose income exceeds the Roth limits might turn to a strategy called the “ backdoor Roth IRA ,” which means contributing first to a non-deductible IRA and then subsequently converting it to a Roth . In 2024 , single filers with a modified adjusted gross income above $ 161,000 and married couples whose incomes are above $ 240,000 are ineligible to contribute to a Roth IRA directly . But the backdoor Roth strategy allows them to navigate around these limits , since the nondeductible contribution to the traditional RIA has no income limits .

Since taxes have already been paid on the nondeductible contribution , the subsequent conversion to a Roth typically incurs little or no additional tax liability , though it depends on whether there are earnings on the contributed amount between the time of contribution and conversion . To minimize any earnings , and thus minimize taxes , the account holder will usually want to complete the conversion promptly after the contribution to the traditional Roth .

24 | FINANCIAL ADVISOR MAGAZINE | SEPTEMBER 2024 WWW . FA-MAG . COM