By Liz Weston, NerdWallet
If you’ve saved a lot for retirement, or your parents have, you could be affected by recent changes in the rules about retirement distributions.
The recently enacted Secure Act eliminated the “stretch IRA,” a strategy used by affluent investors to pass tax-advantaged money to their heirs. The stretch IRA allowed nonspouse beneficiaries — typically children and grandchildren — to take money out of an inherited IRA gradually over their lifetimes. The new law requires most IRAs inherited by people other than spouses to be drained within 10 years, which can lead to much higher tax bills for heirs. (Spouses still have the option of treating an inherited IRA as their own and taking money out over their lifetimes.)
At the same time, the Secure Act delayed
when required minimum distributions have to begin for most retirement
account owners, increasing the age for mandatory distributions from 70
1/2 to 72.
Financial planners say the changes make Roth conversions
more attractive for big savers — typically those with $1 million or
more in their retirement accounts — who want to reduce future tax bills
for themselves or their heirs.
“The percentage of our clients that
do Roth conversions is going to increase dramatically this year,”
predicts certified financial planner Ryan P. Costello of Leawood,
Kansas.
Once
the money is inside the Roth, though, future withdrawals are tax-free.
In addition, there are no required minimum distributions that force
owners to take money out at a certain age.
“What this means to the owner is potentially more efficient tax planning in retirement,
more time for the account to keep growing and a larger nest egg to pass
on,” says certified financial planner David W. Mullins of Richlands,
Virginia.
Still, it doesn’t make a lot of sense to pay a big tax
bill now if the money can be accessed at a lower rate later. That’s the
situation for most people since their tax brackets will drop once they
retire and few have saved enough to leave much to their heirs. Another
barrier to conversion is that people need to be able to pay the tax bill
out of their current income or from nonretirement accounts. (Tapping
the IRA money to pay the tax bill changes the math so much that
conversions are rarely advisable.)
Conversions also can be smart if
the money is intended for heirs whose tax bracket is likely to be at
least as high as the account owner’s. A retiree might not want to
convert if the money will likely go to young grandchildren or other
heirs in lower tax brackets, for example. But if money will be left to
an heir in her peak earning years, conversion may be wise, especially
now that inherited retirement accounts have to be drained within 10
years.
An ideal time for a Roth conversion can be after retirement
but before required minimum distributions begin, financial planners
say. Tax brackets often dip during this period, and the conversion can
be spread over several years to better manage the tax bill. The higher
age for required minimum distributions gives people more time to make
these conversions.
Tax rates can change, of
course, as can tax laws. But the advantages of a conversion can be
substantial enough to make it a gamble worth taking, says Henry Luong
Hoang, a certified financial planner, of Newport Beach, California.
“As
a hedge, if you have the ability to pay reasonable tax rates to convert
your IRA today, there is a very low chance you will regret future
tax-free distributions,” Hoang says.
This article was written by NerdWallet and was originally published by The Associated Press.
How Roth conversions work
A Roth conversion involves transferring money from a traditional IRA or other retirement plan to a Roth IRA. Conversions usually trigger an income tax bill that can be substantial.When conversions can be smart
Conversions can make sense if the IRA owner expects to be in the same or a higher tax bracket in retirement. Good candidates for Roth conversions tend to be diligent young savers who expect their incomes to climb over the years and older people whose tax bills could jump when they start taking required minimum distributions.Get good advice before converting
Getting advice from a skilled tax professional is essential, however. A too-large conversion can push people into higher tax brackets, cause more of their Social Security benefits to be taxed and increase their Medicare premiums. Certified financial planner Linda P. Erickson of Greensboro, North Carolina, recommends hiring a certified public accountant who can model how various conversion amounts are likely to affect current and future tax bills.
The article Who Should Consider a Roth Conversion Now? originally appeared on NerdWallet.
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