Considering a Roth IRA conversion? Here’s how to reduce the tax bite

If you’re considering a Roth conversion, your timing and yearly planning can significantly reduce the tax bite, financial experts say. 

The popular retirement savings strategy allows higher earners to skirt the income limits for Roth individual retirement account contributions. While the maneuver may kickstart tax-free growth, you’ll owe levies on pre-tax deposits.

And boosting your adjusted gross income may have other consequences, according to certified financial planner Ashton Lawrence at Goldfinch Wealth Management in Greenville, South Carolina.

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For example, you may lose eligibility for certain write-offs, such as the child tax credit or student loan interest deduction. And retirees may unknowingly trigger higher Medicare premiums, he said.

Medicare Part B and Part D calculate monthly premiums with your modified adjusted gross income from two years prior, meaning your 2022 income can cause higher costs in 2024.

“That’s a big one that slides under the radar,” Lawrence said.

However, there may be opportunities to help offset the upfront taxes and avoid some of these issues.

The silver lining of market volatility is the ability to pay less tax on Roth conversions.

Sean Michael Pearson

Associate vice president at Ameriprise Financial Services

“Think of a Roth conversion as a juicy steak that you can cook how you want,” said Bart Brewer, a CFP and instructor with Ken Zahn, Inc., based in Santa Monica, California. “There are lots of planning opportunities here if you do your homework.”

Stock market volatility

One opportunity may be timing a Roth conversion with a stock market downturn, like the latest declines triggered by the Russia-Ukraine conflict.

“The silver lining of market volatility is the ability to pay less tax on Roth conversions,” said Sean Michael Pearson, a CFP and associate vice president at Ameriprise Financial Services in Conshohocken, Pennsylvania. 

For example, if you have $10,000 in a pre-tax IRA and there’s a 10% market drop, you’ll convert $9,000 instead of $10,000, saving $220 in federal taxes if you’re in the 22% marginal tax bracket, he said.

Reduce adjusted gross income

If you’re planning a Roth conversion, you may consider reducing adjusted gross income by contributing more to your pre-tax 401(k) plan, Lawrence suggested.

You may also leverage so-called tax-loss harvesting, offsetting profits with losses, in a taxable account. If losses exceed gains, you can use up to $3,000 of capital losses per year to reduce regular income.

And if you’re considering a sizable charitable gift, you may try to send it the same year as the conversion, Brewer said, such as transfers to a donor-advised fund. 

“This strategy is golden if you are charitably inclined and can itemize,” he added.

Roth conversions may make sense in lower-earning years, such as retirees who haven’t started taking Social Security payments. “In broad terms, that’s most likely going to be the sweet spot,” Lawrence said.

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