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Is a Roth Rollover Right for You?

Is a Roth Rollover Right for You?

January 28, 2022

The current tax environment and impact on household income due to COVID-19 has increased opportunity for Roth conversions. Roth conversions can be a great tool for reducing future tax liability because of their tax-free distributions. While this strategy might not be for everyone, here are some reasons to consider a Roth conversion this year:

Current federal income tax rates

When you convert funds from a traditional retirement account to a Roth IRA, you only pay income taxes on the funds in the year you roll the money over. After that, it’s never taxed again. Right now, federal income tax brackets range from 10% to 37%, lower than they’ve been over the last few years, thanks to the Tax Cuts and Jobs Act (TCJA) passed in 2017, set to expire at the end of 2025.

Potentially lower tax bracket

If you’ve experienced a reduction of income or job loss in 2020, you may have dropped to a lower income tax bracket.  That could mean paying even less tax on funds converted to a Roth IRA.

Reduced financial liability during a market downturn

A market downturn may be beneficial if you decide to convert from a 401(k) to a Roth IRA. You pay taxes on the balance that you’re reclassifying. A lower account balance could mean lower taxes. Plus, Roth IRAs usually feature a broader investment universe than 401(k) plans, and your distributions would be tax-free.

Should you do it now with Congress lurking in the wings?

There’s a lot to consider when determining whether a Roth conversion may be right for you now. If you have the cash, it may be right for you and convert as soon as you can. The bottom - line is it's all based on what Congress is going to do.  We know right now you can do it. If Congress says no more Roth IRA conversions in 2022 it's all based on the date the bill is enacted. If Congress does not allow in 2022 your conversion it may be grandfathered in for all Roth conversions done before this enactment date. If Congress says, the Backdoor Roth is gone forever and they say it's retroactive to the beginning of 2022 - this would be the worst case scenario. Based upon past history, Congress has enacted a tax law in the middle of the year and made it retroactive. If they do this in 2022 they would have to allow those who have already converted to get their money back by filling out some type of form or something. It's complicated. You should visit with your Financial and tax professional to determine what is the right move for you. 

If the Backdoor Roth conversion option disappear forever, we still have the option of funding a regular Roth IRA at $6,000 a year for those under age 50 and $7,000 a year for those over age 50. (a $1,000 catch-up provision exist) It may not be a whole lot, but some is better than none at all. You will be happy you did it when retirement comes.