When you first decided to contribute to an IRA or an employer-sponsored retirement account, it probably seemed like a great deal – at least at the time.
After all, you received an upfront tax deduction on the amount you contributed, and you were able to defer paying taxes on any growth in the account. It was a seeming “win-win.”
And in many ways, it is a good thing. But if you think the government gave you that upfront tax advantage with no strings attached, think again. This benefit was conditional, and the condition is that anytime you or your heirs take money out of the account, you will owe taxes on the withdrawals.
If that’s not frustrating enough, the government also gets to change the rules that determine how much is owed when those withdrawals happen. So, perhaps years from now, when you’re retired and need to use some of that money, you may find that your tax rate is much higher than it is today. Or you may learn that a rule related to the accounts has changed.
Some rules have already been altered by the SECURE (Setting Every Community Up for Retirement Enhancement) Act of 2017. One change involved the age at which you have to start taking required minimum distributions (RMD). Previously, once you reached 70½, you had to begin taking a certain percentage out each year (and be taxed on it) whether you needed the money or not. The RMD age was changed to 72, giving you an extra 18 months before it kicks in.
But before you start celebrating, remember this: The tax cuts for individuals that were passed in 2017 are set to expire at the end of 2025. So as things stand right now, taxes will be going up in 2026, and when your RMDs kick in , you could be paying a higher tax rate than you currently are.
Here’s another change: Congress eliminated one of the biggest tax benefits of inherited IRAs. In the past, your beneficiaries could defer paying the taxes on inherited IRAs over their lifetime simply by letting that money sit. But now, non-spousal heirs must cash in the accounts within 10 years of your death – and pay the taxes that come along with doing so. There’s a good chance they will still be working at the time, so those withdrawals will be added to their regular income, possibly thrusting them into a higher tax bracket.
Lower Taxes in Retirement? Maybe Not
Finally, here’s one more thing to consider regarding that money that’s going into an IRA, 401(k) or other tax-deferred retirement account. Most Americans have been conditioned to believe that they will be in a lower tax bracket when they retire. As a result, they reason that when they do withdraw money from their retirement savings, they will be paying at a lower rate than they would be now.
But this may or may not be true depending on the declared tax rates at that time.
And what may be even more relevant under the new IRA rules is the tax bracket your heirs will be in. Even if they are retired themselves, having to cash out the entire IRA they inherited over a brief time span may put them in the highest possible tax bracket. To make matters worse, many heirs live in states that impose state income taxes in addition to the federal tax rate.
So, what to do about this situation? Essentially, there are two choices:
- You can follow antiquated conventional wisdom and continue to defer paying taxes for as long as possible.
- Or you can start converting part of your IRA to a Roth IRA, which can make a significant difference in your favor in how much you will pay in taxes.
Pay Now Vs. Pay Later
Roth IRAs grow tax free, and when you make qualified withdrawals from them, the withdrawals are not considered taxable income. In other words, when you reach retirement and need the money, you can take money from the account without paying a cent of tax on it, as long as you’re 59½ or older and have held a Roth account for at least five years.
Of course, you might ask, “Won’t I have to pay taxes when I make the conversion to the Roth?”
Absolutely. And let’s face it, the notion of voluntarily paying taxes sooner rather than later seems antithetical to the way most of us are wired. The IRS may even be relying on that notion to maximize tax revenue. Most people (and most accountants) would simply prefer to kick the can down the road and minimize this year’s taxes rather than worry about taxes at some unstated date in the future.
But under the new IRA rules, combined with the 2026 increasing tax brackets, the “pay-as-late-as-possible” approach will result in the most tax revenue for the IRS. If you want to reduce your family’s overall tax bill, you should be acting now.
For most people, there will be a substantial discount to convert a portion of their IRA to a Roth each year until 2026, when tax rates are scheduled to increase.
In the process of doing it, though, there are several questions to consider:
- What is the size of your IRA?
- What is your marital status?
- What is your projected income over the next several years?
- What is the projected income of your IRA beneficiaries?
- What state do they live in?
- What is their marital status?
With the answers to these questions in mind, you should speak with your financial advisor or tax consultant as soon as possible to determine the optimal timing and amount of your Roth conversion strategy.
Ronnie Blair contributed to this article.
Singer Wealth Advisors is an SEC-registered investment advisory firm. Singer Wealth Advisors does not provide tax, legal or accounting advice. This material has been prepared for informational purposes only. You should consult your own tax, legal and accounting advisors before making any decisions that may have tax consequences.
President, Singer Wealth Management
Keith Singer, owner and president of Singer Wealth Management (www.singerwealth.com), is a CERTIFIED FINANCIAL PLANNER™. His firm, Singer Wealth Advisors, is a Florida registered investment advisor. Mr. Singer is also a licensed Florida attorney. He is the host of the radio show “Prosper! With Keith Singer,” which currently airs on five in South Florida.