As a part of the CARES Act, Required Minimum Distributions (RMDs) are not required for any IRA account types in 2020. This will reduce the taxable income for those used to taking RMDs from IRAs. In addition, it will give those with Inherited Roth accounts another year to keep growing their money tax free.
If you are used to taking $50,000 or more from your IRA in annual RMDs, your reduction in taxable income will be significant. But, before you celebrate that reduction in taxable income, think about doing a partial Roth Conversion. Now could be the perfect time to do one, especially if you think your tax liability is going to increase over the coming years.
Partial Roth Conversion
A Roth Conversion consists of taking money from a traditional IRA and rolling it over to a Roth IRA. Worth noting, Roth Conversions are not required to be done on 100% of your IRA money. Someone with $500,000 in their IRA may choose to roll $25,000 over in a Roth Conversion. The IRA account holder has flexibility when it comes to doing a partial Roth Conversion.
Here is how to do a partial Roth Conversion:
- Create liquidity in your IRA
- Open a Roth IRA account
- Transfer whatever amount you want from your IRA over to your Roth.
Remember, you will owe taxes on the amount taken from your IRA. Therefore, many people choose an amount that brings them up near the next tax bracket, but not into the next bracket.
Doing a Roth Conversion has multiple benefits:
- You reduce the amount in your IRA that next year will be subject to RMD…ie, your 2021 RMD will be smaller than it would be otherwise.
- The money in your Roth account is not subject to RMD….so, rather than being forced to start withdrawing funds at the age of 72, you can now simply let that money grow untouched.
- From an estate planning perspective, an inherited Roth IRA will not trigger any tax liability for the inheritor like a traditional IRA will.
Higher Tax Rates to Come
If you believe that tax rates will be higher in the future then they are today, you should consider what you can do to lower your future tax burden. A Roth Conversion and subsequent reduction in taxable income from RMDs may be exactly what you are looking for. Especially if you live in a state that does not currently tax retirement income (like Illinois), but may well do so in the future, despite what the politicians promise. Lastly, if you think your beneficiaries may end up facing a higher tax rate structure in their lifetime, then a Roth Conversion also makes a lot of sense.
The deadline for Roth Conversions is December 31st. So you’re running out of time if you want to do a conversion. Schedule a meeting with us if you’d like to learn more about the process.