Roth IRA Conversions: 2 Essential Questions to Ask Before 2022

December 12, 2021

The Roth IRA is a sharp arrow in the retirement planning quiver. While high earners are unable to directly access this tax-advantaged tool, they can convert a traditional IRA to a Roth IRA. This strategy, known as the “backdoor Roth conversion,” may possibly be phased out in 2022. If you’ve been eyeing the Roth IRA, it may be time to shoot your shot.

Knowledge is power, so head into 2022 with confidence by asking these 2 key questions to determine if the Roth IRA is right for you.

Why should I consider a Roth IRA Conversion now?

Large financial decisions should never be made hastily, but Congress’s Build Back Better Act is giving us a reason to hit the gas as 2021 comes to a close. If the bill passes through the Senate, it may bring an end to the backdoor Roth IRA conversion, the method used by high earners to sidestep Roth IRA income limits. Beginning January 1, 2022, high earners may not be able to make today’s conversions, which will curb benefits like tax-free withdrawals upon retirement.

If you exceed the 2021 Roth IRA income limit of $140,000 as an individual or $208,000 as a couple, this may be your last chance to consider the Roth IRA conversion. 

What are the pros and cons of a Roth IRA conversion?

As with any large financial decision, a successful Roth IRA conversion requires weighing a wide array of variables, like your retirement goals and the status of your estate plan. Consider the following as food for thought, but be sure to reach out to a financial professional before making any big moves.

Potential Benefits of a Roth IRA conversion:

  • Roth IRAs can decrease your tax burden. One of the greatest benefits of the Roth is this: once you are 59 ½ years old and have had your Roth IRA for at least 5 years, you can withdraw money from your account without owing federal taxes. If you anticipate that you’ll be in a higher tax bracket at retirement than you are today, then you will likely pay less in taxes over your lifetime with a Roth IRA than with a traditional IRA.
  • Roth IRAs can decrease the tax burden for your heirs. Converting to a Roth IRA can be the best way to maximize financial gifts to your heirs. Since 2019, inheritors are required to close inherited IRA accounts within 10 years of receiving the accounts. This means that if heirs receive a traditional IRA, they may be on the hook for substantial tax bills once they start to make withdrawals. Alternatively, the original IRA owner could convert the traditional IRA to a Roth IRA before passing down the estate. In this case, there would be no tax consequences for the inheritors because the distributions from Roth IRAs would not be subject to federal taxes.
  • No required minimum distributions. If you don’t need your Roth IRA to support your retirement, you can let the money continue to grow in your account. If your goal is to pass along your account to your heirs, this can be another way to maximize the value for your recipients.
  • No penalties on contributions’ withdrawals. Contributions can be withdrawn at any time, tax-free. 

Potential Drawbacks of a Roth IRA conversion:

  • Your post-conversion tax bill may be significant. Say most of your traditional IRA contributions are deducted from your income. In this case, most of the money in your traditional IRA will likely count as taxable income once you convert it to the Roth. If the conversion is big enough, it may also bump you up to a higher tax bracket. 
  • If you’re not careful, you could be double-taxed. If you have other retirement accounts, like a SEP IRA or SIMPLE IRA, they must also be factored into your tax calculations. The IRA accounts’ characteristics, particularly what proportion of funds are pre-tax versus after-tax, will dictate your final tax bill. A miscalculation of this ratio risks double taxation. To accurately determine the tax consequences of your conversion, it’s vital to take a deep dive into your retirement accounts and tax records with your trusted accountant and financial advisor.

Big Shifts are Coming in 2022 – Are You Ready?

Time to take out the guesswork, drill down to the details, and figure out if a Roth conversion is right for you. We’re ready to make sure that you’re in good financial shape so that you can start the year strong.

Reach out to an SWM Wealth Advisor today

Singer Wealth Management