Between the SECURE Act and the CARES Act, retirement plan rules have seen some dramatic changes so far this year. Current retirees, as well as workers who are nearing retirement, should be aware of retirement plan changes that could have a favorable impact. First, consider whether it makes sense to convert your traditional IRA to a Roth IRA. If that’s something you’ve thought of doing in the past, this may be the right time to take that step. Second, if you’re taking required minimum distributions from a retirement account, you don’t have to do so this year. However, should you?
Read on for a discussion of the factors that go into each decision. Above all, please consult with your trusted strategic advisor for advice tailored to your personal situation.
Retirement Plan Changes: Converting a traditional IRA to a Roth IRA
First, a quick reminder of the differences between these two types of accounts:
- Traditional IRAs allow you to deduct your contributions in the year that you make them, effectively lowering your taxable income that year. You don’t pay any tax on the growth until you get to the point of withdrawing funds. When you withdraw the income in retirement, you pay taxes on your withdrawals. Traditional IRAs are generally recommended for people who expect to be in an equal or lower tax bracket in retirement than during their working years.
- Roth IRA contributions are made with after-tax dollars, so you don’t receive a deduction during your working years. The big advantage of a Roth IRA is that earnings are not taxed. You don’t owe any tax when you withdraw your funds in retirement.
There are a variety of reasons to convert a traditional IRA to a Roth, and now may be a good time for some account holders to consider doing so. If you do convert, keep in mind that you’ll have to pay the taxes on the converted amount; once the conversion is complete, earnings and distributions are not subject to tax.
Why is now a good time to convert? It really depends on your circumstances, but here is a list of factors to consider that may apply to you.
- Many IRAs have lost value, which means you may be able to take advantage of a lower conversion tax if you convert before the market recovers. However, if you still expect to be in a lower tax bracket in retirement, converting may not make sense.
- Because of recent government spending that has raised the federal deficit, many analysts predict that tax rates will increase in the future. Converting now, when tax rates are relatively low, may be advantageous.
- If you’ve lost income in 2020, or project a loss for the year, then you may be in a lower tax bracket than usual, thereby reducing the cost of a conversion.
- Can you pay the taxes on the conversion without using the IRA funds themselves? Ideally, the answer is yes, allowing you to reap the full tax benefits as the Roth IRA continues to grow over time.
- If you’re currently on Medicare, keep in mind that your conversion income may impact what you pay in Medicare premiums in years to come.
- You won’t be able to back out once you’ve made your decision, as the 2017 Tax Cuts and Jobs Act ended the ability to reverse a conversion for tax purposes.
Because of all the nuances and potential tax implications, converting your IRA to a Roth is an area where it’s worth consulting with a professional. Although there’s no future-proof choice, we can run the numbers to identify the best decision for you at this time.
Required Minimum Distributions under the CARES Act
The SECURE Act raised the age on IRA required minimum distributions (RMDs) from 70 1/2 to 72, beginning in 2020. The CARES Act put a temporary moratorium on all RMDs (from IRAs and 401(k) plans) for the duration of 2020. If you don’t need the funds, it may be a good idea to leave them in your account and give the balance some time to recover. Even if you already took your RMD, you still have the option to return it to the account and wait for the market to improve. However, depending on your tax situation, it may be advantageous for you to take the RMD as planned. Be sure to consult with your financial advisor for a personalized analysis.
For an in-depth discussion of the factors involved in the RMD rules under the CARES Act, listen to the AICPA’s podcast on the topic. Learning about these retirement plan changes can help you make informed decisions this year.