Should You Consider a Roth Conversion Before the Expiration of the TCJA?

As you plan for retirement, every decision you make now can significantly impact your financial future. One of the most pressing questions you might be facing is whether to execute a Roth conversion, especially with the expiration of the Tax Cuts and Jobs Act (TCJA) on the horizon. Let’s dive into what this means for you and whether a Roth conversion could be right for you.

Understanding the TCJA and Its Expiration

The Tax Cuts and Jobs Act passed in 2017, brought about some of the most substantial changes to the tax code in recent history. It lowered income tax rates, doubled the standard deduction, and capped certain itemized deductions, among other things. These changes have allowed many taxpayers to enjoy reduced tax liabilities over the past few years.

However, unless Congress extends it, the TCJA will expire on December 31, 2025. When it does, tax rates are expected to revert to their pre-2018 levels, meaning higher taxes for many people. This potential increase has many individuals, like yourself, wondering whether they should lock in today’s lower tax rates through strategies like a Roth conversion.

What Is a Roth Conversion?

Before deciding, it’s crucial to understand what a Roth conversion entails. If you have money in a traditional IRA or 401(k), that money has been growing tax-deferred—meaning you haven’t paid taxes yet. When you withdraw it in retirement, you’ll owe taxes at your ordinary income tax rate at that time.

A Roth conversion allows you to transfer some or all of that money into a Roth IRA. In doing so, you’ll pay taxes on the converted amount now at today’s tax rates. However, once the funds are in the Roth IRA, they grow tax-free, and when you withdraw them in retirement, you won’t owe any taxes on those withdrawals. It’s essentially paying taxes now to avoid paying them later.

Why You Might Consider a Roth Conversion Before the TCJA Expires

There are several reasons why a Roth conversion could be particularly appealing before the TCJA expires:

1. Locking in Lower Tax Rates: With the possibility of tax rates increasing after 2025, converting now allows you to pay taxes at today’s lower rates. This conversion could save you a significant amount in taxes compared to waiting until after the TCJA expires.
2. Tax-Free Growth: Your money can grow tax-free once you invest in a Roth IRA. Any investment gains, dividends, or interest earned within the account will not be subject to taxes, maximizing your retirement savings.
3. No Required Minimum Distributions (RMDs): Roth IRAs don’t require you to take distributions at age 72, unlike traditional IRAs. This time duration gives you more flexibility to let your money grow tax-free for as long as you like, potentially leaving more for your heirs.
4. Flexibility in Retirement: Since Roth IRA withdrawals are tax-free, you’ll have more control over your taxable income in retirement, which can help you manage your tax bracket and avoid higher taxes on Social Security benefits or Medicare premiums.

What Are the Downsides?

While a Roth conversion offers several potential benefits, it has its drawbacks. Here are a few considerations to keep in mind:

1. Upfront Tax Cost: Converting to a Roth IRA requires paying taxes on the amount converted. Depending on the size of your conversion, this could result in a significant tax bill. Make sure you have the cash available to cover this cost without dipping into your retirement savings.
2. Impact on Other Financial Goals: Paying taxes now could impact other areas of your life. It might leave you with less money for other priorities, like saving for a child’s education, buying a home, or building an emergency fund.
3. Potential for Higher Medicare Premiums: A large Roth conversion could push you into a higher tax bracket for the year, which might increase your Medicare premiums. It’s important to carefully plan the amount you convert each year to avoid unintended consequences.
4. State Taxes: Don’t forget about state taxes. Depending on where you live, your Roth conversion could be subject to state income taxes, which could add to the overall cost.

Should You Move Forward?

So, should you proceed with a Roth conversion before the TCJA expires? The answer depends on your unique situation. It’s not just about the numbers—it’s about your goals, your plans for the future, and your comfort level with paying taxes now for the benefit of tax-free income later.

If you’re considering a Roth conversion, it might be wise to discuss it with a financial advisor. They can help you weigh the pros and cons and determine whether it’s the right strategy for you. Remember, the decisions you make today will shape your retirement tomorrow. Take the time to explore your options and make the choice that best aligns with your vision for the future.

At Four Leaf Financial Planning, we’re here to help you navigate these decisions. If you’re considering a Roth conversion or want to explore other strategies to maximize your retirement savings, schedule some time with Kathleen or download our Roth Conversion Q&A Guide to answer some important questions.