Is it Time to Convert Your IRA? Tax Law Changes to Consider
Introduction
As we continue into 2022, changes in tax laws may have you wondering if it’s time to convert your traditional IRA into a Roth IRA. With the potential for higher taxes on the horizon due to the recent tax law changes, converting your IRA could potentially save you money in the long run. This post will guide you through key concepts, potential pitfalls, practical strategies for 2025, and frequently asked questions to help you make an informed decision.
Key Concepts to Understand
Before deciding whether to convert your IRA, it’s essential to understand the difference between a traditional IRA and a Roth IRA. Contributions to a traditional IRA are tax-deductible, but withdrawals in retirement are taxed as ordinary income. Meanwhile, Roth IRA contributions are made with after-tax dollars, meaning withdrawals in retirement are tax-free.
The new tax laws have introduced changes in tax brackets and deductions, which might make Roth conversions more appealing for some. For example, the Tax Cuts and Jobs Act of 2017 lowered individual income tax rates but these cuts are set to expire in 2025. This could result in higher future taxes for retirees.
Avoiding Costly Mistakes
One common mistake is not considering the tax implications of an IRA conversion. Converting a traditional IRA to a Roth IRA is a taxable event. You’ll have to pay taxes on the amount you convert at your current tax rate. If you convert a large amount, it could potentially push you into a higher tax bracket.
Another mistake is not considering your future tax situation. If you anticipate your tax rate will be lower in retirement, it might be better to stick with a traditional IRA.
Practical Strategies for 2025
With the potential expiration of the tax cuts in 2025, it might be wise to start planning now. One strategy is to convert a portion of your traditional IRA to a Roth IRA each year, spreading out the tax burden over several years. This approach, known as “tax bracket management”, can help avoid moving into a higher tax bracket in any given year.
Another strategy is to convert your IRA in a year when your income is lower, reducing your overall tax liability.
Frequently Asked Questions
Q:
What if I can’t afford to pay the taxes on a Roth conversion now?
A:
If you can’t afford to pay the taxes on a Roth conversion out of pocket, it might not be the best move for you. Paying the taxes with funds from your IRA can result in penalties, especially if you’re under age 59½.
Q:
Can I undo a Roth IRA conversion if I change my mind?
A:
Since 2018, recharacterizations of Roth conversions are no longer allowed. This means once you’ve converted to a Roth IRA, you can’t undo it.
Closing Thoughts
Deciding whether to convert your IRA is a complex decision that depends on your current tax situation and future tax expectations. It’s essential to consider all the factors and consult with a financial advisor before making a decision.
Take Action Now
If you’re considering a Roth conversion, don’t navigate this complex financial terrain alone. Click on this link to connect with a financial advisor who can provide personalized advice based on your unique financial situation. Make this year the year you take control of your retirement future.