Time is Running Out on Roth Conversions for 2022

Time is Running Out on Roth Conversions for 2022

For many, a down market is cause for concern; but for others, there are opportunities to be had! One such perk is the Roth IRA conversion. If you’ve been considering a Roth IRA conversion, now might be the time to do it – especially if you’re looking to reduce your tax burden substantially. Keep in mind as we rapidly approach the end of the year (yes folks, soon enough, the holidays will be upon us!) that the deadline for converting into a Roth IRA – from a traditional IRA or a 401k – is December 31st.

Typically, you might not consider a decline in your portfolio very advantageous. However, if you currently have funds in traditional pre-tax IRAs, the lower value could make it cheaper to convert your funds into a Roth IRA.

What’s the difference between a traditional IRA and a Roth IRA?

While both offer tax savings, they differ in the timing of those savings. Where traditional IRAs utilize pre-tax money for contributions and are taxed upon withdrawal in retirement, Roth contributions are funded with post-tax dollars, but retirement withdrawals are tax-free.

Additionally, Roth IRAs have no Required Minimum Distributions (RMDs), allowing you to withdraw your money when you want to – making them great for anyone who isn’t fully retired. Traditional IRAs require account holders to take RMDs once they’ve reached the age of 72 – regardless of their income needs. And, if you’re a high-income earner, Roth IRAs have notoriously been off the table.

The strategy for high-income earners: The Backdoor Roth IRA

Traditionally, high-income earners cannot open Roth-style accounts due to regulatory income caps. In 2022, those are $144,000 for individuals and $214,00 for married couples. However, Roth Conversions offer a workaround – the backdoor Roth IRA. Most high-income earners can contribute to traditional IRAs and then perform Roth IRA conversions throughout their lifetime to continue taking advantage of tax-free growth. Remember that this is a legal loophole to get around income limits; it is not a tax dodge. You may incur higher taxes upon establishment, but you’ll gain the future tax savings of a Roth account.

There are three ways to create a Backdoor Roth IRA:

  • Fund a traditional IRA and then roll over whatever funds you choose to a Roth
  • Convert your entire traditional IRA to a Roth
  • If your plan allows conversions, roll over your 401(k) to a Roth IRA
The tax implications of a Roth IRA

The most significant caveat to a Roth conversion is the tax bill due upon the rollover. Because contributions to traditional IRAs are made with pre-tax dollars, all transferred funds are eligible to be taxed at ordinary income tax rates. To prevent a sizable tax event, spread the conversion over several years.

If you’re confident you’ll be in a higher tax bracket in retirement, it might make the most sense to foot the higher bill now to enjoy the tax-free withdrawals down the road. But be careful about the funds you use to cover your conversion taxes – it makes more sense to pay with cash from savings than to pull it from your retirement account (potentially costing thousands in growth over the long term). Reach out to an expert if you’re unsure.

When is the best time for a Roth Conversion?

Right now, while the market is down. Not too long ago, we gave you some advice about staying calm in a market downturn – don’t time the market, stay invested, and control what you can. While waiting for the market to work through its cycles, why not convert your traditional IRA portfolio (while its value is down) to one that offers more flexibility and tax-free investment growth in retirement?

While today’s sluggish economy is unsettling, it’s the perfect opportunity to take advantage of the circumstances and control what you can control – the goals of your long-term investment plan. Why not do so by minimizing the tax liability generated by a Roth conversion now? If the value of your traditional IRA portfolio has declined (which is the unfortunate reality currently affecting many people), convert your assets at the lower value and take advantage of lower tax liability. Once the market rebounds, the gain on your rolled-over assets will be tax-free!

Is time running out for future Roth conversions?

Although no longer at risk of being eliminated in 2022, the future of the Backdoor Roth IRA remains a target of proposed legislation. Some legislative efforts have already been taken to limit Roth IRAs or to change tax brackets and RMDs in the future. With that said, this is one of those times we don’t suggest waiting to find out.

And since we still can’t predict the future, today’s benefits – the lack of required RMDs coupled with relatively low tax rates – could make now as good a time as any for a Roth IRA conversion. As always, we recommend weighing all up-front costs and consequences and consulting with a financial expert before making any substantial changes to your plan. Not everyone who considers Roth conversions takes action after all variables are considered. If you’re looking for help with your investments and financial future, we encourage you to schedule your 15-minute complimentary call today!


More About the Author: Sheena Hanson