Consider a Roth Conversion for Tax-Free Income

The combination of lower tax rates and lower asset values could make this a good time to convert assets from a traditional IRA to a Roth IRA. Converted assets are subject to federal income tax in the year of conversion, which might be a substantial tax bill. But if all conditions are met, the Roth account will incur no further income tax liability for the rest of your lifetime or the lifetimes of your designated beneficiaries, no matter how much growth the account experiences.

Tax Tradeoff

The logic behind deferring taxes on retirement savings is that you may be in a lower tax bracket when you retire, so a current tax deduction might be more appealing than tax-free income in retirement. However, lower rates set by the Tax Cuts and Jobs Act may have changed that calculation for you. A cost-benefit analysis could help determine whether it would be beneficial to pay taxes on some of your IRA assets now rather than in retirement. One strategy is to “fill your tax bracket,” meaning you would convert an asset value that would keep you in the same tax bracket. This requires projecting your income for 2020.


Lower Values, More Shares

If assets in your traditional IRA have lost value, you will pay income taxes on a lower asset base when you convert. As long as your traditional and Roth IRAs are with the same provider, you can typically transfer shares from one account to the other. Thus, when share prices are lower, you could theoretically convert more shares for each taxable dollar and would have more shares in your Roth account to pursue tax-free growth. Of course, there is also a risk that the converted assets will go down in value. You may have the option to take taxes directly out of your converted assets, but this is generally not wise.

Two Time Tests

Roth accounts are subject to two different five-year holding requirements: one related to withdrawals of earnings and the other related to conversions.

For a tax-free and penalty-free withdrawal of earnings, including earnings on converted amounts, a Roth account must meet a five-year holding period beginning on January 1 of the year your first Roth account was opened, and the withdrawal must take place after age 59½ or meet an IRS exception. If you have had a Roth IRA for some time, this may not be an issue, but it could come into play if you open your first Roth IRA for the conversion.

Assets converted to a Roth IRA can be withdrawn free of ordinary income tax at any time (because you paid taxes at the time of the conversion), but a 10% penalty may apply if you withdraw the assets before the end of a different five-year period, which begins on January 1 of the year of each conversion, unless you are age 59½ or another exception applies.

Even if you are close to retirement or already retired, a Roth conversion can make sense to provide tax-free income. Unlike a traditional IRA, Roth IRAs are not subject to required minimum distribution rules during the lifetime of the original owner.* The longer your investments can pursue growth, the more advantageous it may be for you and your beneficiaries to have tax-free withdrawals.

All investing involves risk, including the possible loss of principal, and there is no guarantee that any investment strategy will be successful.

 
Wells Fargo Advisors - Wealth Management & Financial Advisors
975 OAK ST, SUITE 1080 Eugene, OR 97401
Phone: (877) 778-9508

Wells Fargo Advisors does not render legal, accounting, or tax advice. Please consult your tax or legal advisors before taking any action that may have tax consequences. Wells Fargo Advisors did not assist in the preparation of this material, and its accuracy and completeness are not guaranteed.

This information is intended for use only by residents of (AK, AL, AR, AZ, CA, CO, CT, DE, FL, GA, HI, IA, ID, IL, IN, KS, KY, LA, MA, MD, MI, MN, MO, MS, MT, NC, NH, NJ, NM, NV, NY, OH, OK, OR, PA, RI, SC, SD, TN, TX, UT, VA, VT, WA, WV, WY). Securities-related services may not be provided to individuals residing in any state not listed above.

For parties residing outside of the U.S., this information is: (i) provided for informational purposes only, (ii) not and should not be construed in any manner as an offer to participate in any investment or to buy or sell any securities or related financial instruments, and (iii) not and should not be construed in any manner as a public offering of any financial services, securities or related financial instruments.

Products and services listed may not be available, or may have restrictions, depending on client country of residence.

Investment and Insurance Products Are:
  • Not Insured by the FDIC or any Federal Government Agency
  • Not a Deposit or Other Obligation of, or Guaranteed by, the Bank or Any Bank Affiliate
  • Subject to Investment Risks, Including Possible Loss of the Principal Amount Invested

Investment products and services are offered through Wells Fargo Advisors. Wells Fargo Advisors is a trade name used by Wells Fargo Clearing Services, LLC, Member SIPC

A note about Social Media: Opinions, comments and actions taken on Social Media are those of the third party and do not necessarily reflect the views of the creator of this profile or of the firm. Social Media is intended for U.S. residents only and subject to the following terms: wellsfargoadvisors.com/social.

Links to third-party websites are provided for your convenience and information purposes only. Wells Fargo Advisors is not responsible for the information contained on third party websites.

©2021 Wells Fargo Clearing Services, LLC. All rights reserved.

FINRA’s BrokerCheck Obtain more information about our firm and its financial professionals
FINRA’s BrokerCheck Obtain more information about our firm and its financial professionals