Those With Large IRAs Need Roth Conversions Now, Ed Slott Says
From: www.fa-mag.com
Now that the Internal Revenue Service has released its final regulations on required minimum distributions for IRAs, inherited IRAs and 401(k)s, clients with large tax-deferred accounts need to seriously consider Roth conversions before 2017’s tax rate cuts expire at the end of 2025, said IRA expert Ed Slott.
The reason? The current marginal tax rates may never be this low again, he said. The 2017 Tax Cuts and Jobs Act lowered most of the seven tax brackets by between 1% and 4%, and unless those cuts are made permanent, 2026 will see them revert back to prior levels.
Advisors today therefore should be helping their clients reduce their IRA balances as much as possible, Slott said last week during an online seminar for advisors where he discussed the IRA changes.
“The plan should be to get that money out while these rates are low. Don’t waste those low tax brackets. Think maximum, as in, ‘How much can I get out while taxes are on sale?’ not minimum,” he said. “You have to assume you have two more years. This year, 2024, and next year 2025.”
By biting the bullet now and paying owed taxes on a Roth conversion, clients will set themselves up for years, maybe decades, of tax-free growth and distributions, something Slott said he has done with all of his own retirement accounts.
All Advisors Are Tax Planners
Even advisors who say they don’t do tax planning need to recognize that every time they touch an IRA—or give advice on a rollover or Roth conversion—they are in fact doing tax planning, Slott said.
And now’s the time to be proactive. “You should be contacting every client with the largest IRAs. The people in their 60s are in the sweet spot.”
Slott said there are two primary ways to bring taxes down when it comes to high-balance retirement accounts.
The first is to convert traditional IRAs to Roth IRAs so clients pay taxes now while tax rates are lower.
The second is to stop contributing to a 401(k) and instead contribute to a Roth 401(k). “The deduction for a 401(k) contribution is really a loan you’re taking from the government to be paid back at the worst possible time,” he said. “Now is the time to deconstruct and get the assets into safer vehicles for the long term.”
Quell Those Objections
In either case, client objections may include their expectation that they’ll be in a lower tax bracket when they get to retirement, but most likely they’re wrong, Slott said.
Clients who are big earners and in the top bracket now most likely will always be in the top bracket, he said.
“Even outside their IRAs they’re generally good savers and investors, and they have other assets,” he said. “So the fact that they might not have a W-2 does not mean they may not be in the top bracket in retirement.”
Another common client worry is what the ballooned income from a Roth conversion can do to their income-related monthly adjustment amount (IRMAA) determination for Medicare. But clients worried about that are not seeing the forest for the trees, Slott said, since paying an additional few hundred dollars a month for a year before the IRMAA resets is nothing compared to the tens of thousands paid on IRA distributions over a retirement.
“I’d rather you be angry for one year than for the rest of your life,” he told one client.
Inherited IRAs
Slott said the new rules for distributions have turned IRAs into “probably the worst asset” for wealth transfer or estate planning. (One area where they’re still valuable is charitable giving, as the receiving charity will receive the assets tax-free, he said.)
While clients can often choose when they start taking their own RMDs, that’s not so with an inheritance. Beginning in 2020, clients who inherited an IRA after the owner started taking required distributions can no longer stretch the payments over their own lifetime. Instead, they have 10 years to empty the account, often taking them in years one through nine.
The good news is people who inherited in 2020 but haven’t been taking the distributions as they awaited the IRS’s rules will not be penalized for not taking them, nor will they have to make up the back RMDs, Slott said.
“But is that a good plan?” he questioned. “Let’s say you had that client who inherited a large IRA in 2020, they’re subject to the 10-year rule, and they have to take RMDs. But should they just take the minimum? This is where you come in. You have to change the whole mentality.”
A better strategy, Slott said, is to focus on the tax rates, not the required distributions.
“Ignore RMDs. You shouldn’t be letting RMDs control the tax planning. The tax planning should be controlling the distributions,” he said, adding that clients might need help in thinking about lifetime taxes, not just taxes in any one given year.
Because no matter what, that inherited IRA will be dissolved by year 10, and there’s a good chance tax rates will not be as favorable then.
“That’s the key to tax planning—taking advantage of low brackets each year,” he said.
