For Roth Conversion Fans, the Tax Sale Is On!
The December 31st deadline is fast approaching which means it’s time to start thinking about whether a Roth Conversion is right for you. The biggest factor in making this decision comes down to whether tax rates in the future will be higher than they are today. If you believe your taxes are going up, then it makes sense to pay your taxes while they’re at a discount!
In the past, investors often made decisions about Roth IRAs based on their observations about the fiscal trajectory of our country. Would unfunded obligations like Social Security and Medicare coupled with our massive $21 Trillion debt burden force tax rates up over time? The answer for many Americans was yes, but one question always remained: when will taxes be going up and by how much? This uncertainty has led many Americans to simply postpone making any decisions about Roth Conversions. Afterall, who wants to pay a tax before the IRS absolutely requires it of them only to regret it later on?
Well, all that uncertainty and doubt disappeared when Congress passed the Tax Cuts and Jobs Act of 2017. With the stroke of the pen, Donald Trump enacted an 8-year period of historically low tax rates. Instead of guessing when tax rates are going to go up, we now know the year and the day when taxes will go up: January 1st 2026. Put differently, in order for your tax rates to go up eight years from now, all Congress has to do is nothing (and Congress is pretty good at doing nothing!).
Every year between now and 2026 represents a little window of opportunity within which to take advantage of historically low tax rates. And each year that goes by where you fail to convert your IRAs is potentially a year beyond 2026 when you could be forced to liquidate those IRAs at the highest tax rates you’ll see in your lifetime.
To appreciate how good this tax sale really is, calculate the taxes you might pay for converting your IRA in 2018 versus a similar conversion under last year’s tax code. For example, let’s assume that as a married couple filing jointly, you had taxable income in 2017 of $100,000, putting you squarely in the 25% tax bracket. That means you could have converted an additional $53,100 before bumping up into the 28% tax bracket.
Thanks to the Trump tax sale, you can now perform that same conversion while paying taxes at only 22%. What’s better, the ceiling on the 22% tax bracket goes all the way up to $165,000. That’s a 3% sale on a broader range of taxable income!
But what if converting to the top of the 22% tax bracket isn’t enough to dramatically impact your retirement picture? Then you may want to consider taking advantage of the 24% tax bracket. For only 2% more tax, you can convert all the way up to a $315,000 threshold! In other words, you can protect an additional $150,000 from the impact of higher taxes for a measly 2% more in tax. Converting up to $315,000 in 2017 would have put you in the 33% tax bracket! Talk about a tax sale!
Now just because you’re in the midst of a full-blown tax sale doesn’t mean you should go about converting all your IRAs in a willy-nilly or haphazard way. Your goal should be to convert your IRA dollars slowly enough that you don’t rise into a tax bracket that will give you heartburn, but quickly enough that you get all the heavy lifting done before tax rates go up for good. Stretch the tax liability out over the full eight years to avoid paying any more taxes than are necessary.
Remember, if you don’t act prior to the December 31st Roth Conversion deadline, you’ll only have seven years within which to fully execute your Roth Conversion plan. The fewer years you give yourself, the more likely you’ll bump up into one of the higher tax brackets. That means less money for you and your family in retirement.
Tax rates are poised to revert to their pre-2018 levels in 2026 but the truth is this: they’ll probably go even higher as we approach 2028, 2030 and beyond. As interest rates return to historically normal levels, the cost of servicing our nation’s ever-increasing debt load could triple or even quadruple! This expense could very quickly crowd out important entitlement programs like Social Security, Medicare and Medicaid. To keep these programs solvent, the government will soon need huge infusions of cash. That means higher taxes. All the more reason to take advantage of Roth Conversions before this tax sale is over. Remember, when taxes are on sale, every year matters!
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