If you have been considering a Roth IRA conversion—which is simply a transfer of assets from a Traditional (tax-deferred) IRA to a Roth (tax-free) IRA—but have been hesitant because of the associated tax bill, 2023 might provide just the moment you have been waiting for. With expanded tax brackets now in place thanks to inflation, you can convert more without jumping into the next tax bracket. And with the current tax cuts from the Tax Cuts and Jobs Act (TCJA) of 2017 set to expire at the end of 2025, you will likely pay Uncle Sam less now than you would on the same transaction in the future.
While the sale on taxes can be a compelling reason to consider a Roth IRA conversion on its own, the current market conditions have made it even more appealing. Transferring assets, either cash or securities in-kind, from your Traditional IRA now while they are still at depressed levels (due to the challenging down market of 2022) allows for the eventual recovery to occur in the Roth IRA.
You might be thinking, let’s get this conversion going! But before you dive in, it’s important to consider if it’s truly right for you and supports your larger estate planning goals. A Roth IRA conversion isn’t appropriate if your IRA assets will go to charity at your passing or you intend to process all required distributions through Qualified Charitable Distributions. In both scenarios, you would be pre-paying a tax bill that would never materialize. Additionally, a conversion doesn’t make sense if you know you’ll need your IRA during your lifetime and are likely to spend it down. It’s better to just pay the taxes as you go if that’s the case.
If you think you’ll need to wait until after age 59½ to take advantage of a Roth conversion to avoid the 10% penalty for early withdrawals, you’re in luck. There is a special IRS provision which allows for conversions at any age, but with some important caveats. The entire distribution from the Traditional IRA must be deposited to the Roth, and it must remain there for at least five years. And if you have taxes withheld on the converted amount, be prepared to pay a 10% early withdrawal penalty on the tax withholding in addition to the taxes themselves. Likewise, if you attempt a withdrawal of converted funds from the Roth IRA for any reason, the 10% penalty will be triggered. Fortunately, the 10% early withdrawal penalty goes away completely once you’re over age 59½.
The ideal candidate for a Roth Conversion:
Has most of their assets in tax-deferred accounts and is looking for tax diversification.
Believes they will be in a higher tax bracket in the future.
Has the cash on hand—outside of the IRA—to pay the taxes due on the conversion.
Wants to pass tax-free assets to their heirs.
If this sounds like you, reach out to your Sand Hill Wealth Manager to start the conversation about a Roth IRA conversion. You will want to be certain that it makes sense for your specific situation as the ability to just say “oopsy daisy!” and undo a Roth conversion no longer exists thanks to the TCJA. When it’s done, it’s done, and the taxes could be due as early as the next quarterly estimated tax payment date.
If you’ve considered conversion in the past but haven’t crossed it off your to-do list yet, just think how satisfying it will be to get that done and early in the new year, too. There may be no time better than the present.
Sources: Charles Schwab, Barron’s, IRS
Articles and Commentary Information provided in written articles are for informational purposes only and should not be considered investment advice. There is a risk of loss from investments in securities, including the risk of loss of principal. The information contained herein reflects Sand Hill Global Advisors' (“SHGA”) views as of the date of publication. Such views are subject to change at any time without notice due to changes in market or economic conditions and may not necessarily come to pass. SHGA does not provide tax or legal advice. To the extent that any material herein concerns tax or legal matters, such information is not intended to be solely relied upon nor used for the purpose of making tax and/or legal decisions without first seeking independent advice from a tax and/or legal professional. SHGA has obtained the information provided herein from various third party sources believed to be reliable but such information is not guaranteed. Certain links in this site connect to other websites maintained by third parties over whom SHGA has no control. SHGA makes no representations as to the accuracy or any other aspect of information contained in other Web Sites. Any forward looking statements or forecasts are based on assumptions and actual results are expected to vary from any such statements or forecasts. No reliance should be placed on any such statements or forecasts when making any investment decision. SHGA is not responsible for the consequences of any decisions or actions taken as a result of information provided in this presentation and does not warrant or guarantee the accuracy or completeness of this information. No part of this material may be (i) copied, photocopied, or duplicated in any form, by any means, or (ii) redistributed without the prior written consent of SHGA. For disclosures, including additional information on credential designations of SHGA representatives please see our Form ADV Part 2A and 2B Disclosure Brochures, which can be obtained by clicking here.
Video Presentations All video presentations discuss certain investment products and/or securities and is being provided for informational purposes only, and should not be considered, and is not, investment, financial planning, tax or legal advice; nor is it a recommendation to buy or sell any securities. Investing in securities involves varying degrees of risk, and there can be no assurance that any specific investment will be profitable or suitable for a particular client’s financial situation or risk tolerance. Past performance is not a guarantee of future returns. Individual performance results will vary. The opinions expressed in the video reflect SHGA's or Brenda Vingiello’s (as applicable) views as of the date of the video. Such views are subject to change at any point without notice. You should not treat any opinion expressed by SHGA or Ms. Vingiello as a specific inducement to make a particular investment or follow a particular strategy, but only as an expression of general opinion. Nothing presented herein is or is intended to constitute investment advice, and no investment decision should be made based solely on any information provided on this video. There is a risk of loss from an investment in securities, including the risk of loss of principal. Neither SHGA nor Ms. Vingiello guarantees any specific outcome or profit. Any forward-looking statements or forecasts contained in the video are based on assumptions and actual results may vary from any such statements or forecasts. SHGA or one of its employees may have a position in the securities discussed and may purchase or sell such securities from time to time. Some of the information in this video has been obtained from third party sources. While SHGA believes such third-party information is reliable, SHGA does not guarantee its accuracy, timeliness or completeness. SHGA encourages you to consult with a professional financial advisor prior to making any investment decision.
