Most people know that we started 2018 with a brand-new tax law (the Tax Cuts and Jobs Act or “TCJA”). Some of the highlights of the TCJA can be found in this linked summary. In addition 2018 is also the 20th Anniversary of the Roth IRA!
In STA Wealth Management’s Retirement Survival Guide, I discuss Planning for Retirement the R.I.T.E. Way® (R.I.T.E. stands for “Retirement Income Taxed Efficiently”). The tax-free retirement Income available in retirement through Roth IRAs (and by using strategic Annual Roth Conversions) is discussed in the Guide and as part of our R.I.T.E. Plan. These strategies will be especially beneficial if we see future rises in our income tax rates (and we are currently at historically low tax rates). Thus, you should consider Roth IRAs as kind of “Tax Insurance” (by paying the “premium” of accelerating and paying taxes now on conversions).
In terms of your personal Retirement Planning, one important change in the new tax law negatively impacted the strategies related to Roth IRAs. Starting on January 1, 2018, you are no longer able to Recharacterize Roth Conversions (but you still can for conversions done during 2017). In past years, recharacterizations allowed you to “undo” any Roth IRA conversion for any reason if you changed your mind. This flexibility allowed you to reverse the conversion with no tax or financial impact all the way until the filing of your tax return in the following calendar year. That could give you almost two years (with extensions until October 15th of the next year) to consider whether the Roth Conversion was the right thing for you based on your tax bracket, market performance and other factors. How often does that tax code allow for a “do over”? Now that his option is GONE (possibly forever), it is very important to still consider Roth Conversions, but do so more strategically.
I have been talking with many friends like Ed Slott (who also wrote a Forward for the Retirement Survival Guide) and Jeffrey Levine. Both are thought leaders in the areas of Roth IRA Planning. This past week in Jeffrey’s Blog, he listed several considerations before converting:
- Meet with your Tax Team to estimate the impact on any Roth Conversion (this could include tax bracket creep, increasing taxes on Social Security and/or Medicare Premiums),
- Review the long-term impact on your financial plan related to “pre-paying” the taxes at today’s lower rates vs. deferring the tax bill,
- Making sure that you are able to pay the additional taxes you will owe,
- Review your market outlook and see if the timing is optimal (if the market falls shortly after the conversion, you will still owe the tax on the original conversion amount).
Jeffery also shared strategies that many of us used in the past and shared some thoughts about strategic Roth IRA Conversations going forward under the new law. Without the ability to recharacterize, it will be risker to convert all at once (as noted above) given the high market valuations and recent volatility we have been experiencing (see webinar on Investing in an Aging Bull Market). I also discuss many if these issues in my recent article on Stress Testing your portfolio.
After talking with these and other experts, our team at STA Wealth has decided to share our ideas on Strategic Roth IRA Conversions for your consideration. Please note that no strategies are guaranteed to work as expected nor are they for everyone. Strategies like Roth Conversations should be reviewed in light of your personal tax and financial planning goals and objectives.
Reviewing Roth Conversions for STA Wealth Clients in 2018 and Beyond
Is a Roth Conversion Right for You?
As part of each client’s Retirement and Financial Plan, STA Wealth’s Financial Planning Department reviews multiple scenarios to determine if strategic Roth IRA Conversions make sense given a cleint’s specific goals and objectives (while reviewing the annual impact on their tax return). Typically, when Planning for Retirement the R.I.T.E. Way®, we use our financial planning software and other tools to analyze their first 10 years of retirement. From those cash flow and tax projections, we come up with specific tax and distribution strategies for the next three years. Many times, benefits come from “managing” tax brackets in early years of retirement to reduce taxation over their lifetime. it is not a quick fix, but rather a long-term plan.
The strategic timing of Roth Conversions may be part of this plan. Conversions may be especially beneficial if their financial plan allows us to take advantage of these timing opportunities. Here are some examples of fact patterns where Roth Conversions may be the most beneficial:
- If you start retirement earlier (especially around age 60) where you are past the 10% Penalty on ANY retirement plan distributions.
- When you have lower taxable income (even better you have not yet started a large pension or your Social Security).
- If you have a reasonable standard of living of living and retirement budget (typically spending under $100,000 per year).
- Where you have retirement assets available from multiple buckets (as I discuss and show a visual in the Retirement Survival Guide). This creates flexibility as to where to draw your “Retirement Paycheck” from to cover your monthly cash flow needs.
STA Wealth’s Roth Conversion Strategy and Timing
If a client’s financial plan reveals that they would benefit from strategic Roth IRA conversions, we will follow our strategy when implementing the Roth Conversion (and this will be reviewed each year):
- We will determine the targeted dollar amount of the annual Roth Conversion (for today’s discussion, we will assume $100,000).
- We will typically consider breaking up that conversion into at least two separate conversions at different times of the year:
- The first one will optimally be timed to coincide with STA’s Investment Committee’s beginning of year Private Client Report and Market Outlook in the first quarter of the year. If you are not a client, you will not get this outlook (thus you should question why you are not a client of STA Wealth??). However, if you are not a client, you can track our 401(k) Plan Manager or read our weekly newsletter that is somewhat tracks our outlook.
- We will tend to start with half of the annual recommended conversion and transfer (thus convert) the portfolio positions with our highest ranking of upside potential to our client’s Roth IRAs. If you want to convert to a Roth, you should consider converting the highest growth potential assets to the Roth IRA as future growth will be Tax-Free!
- We will tend to follow the same process when we release our second half Private Client Report and Market Update (typically in the third quarter of each year).
- If we see any short-term market corrections (similar to what we saw in early February 2018), we may accelerate some of the Roth Conversion.
At STA Wealth, even with the changes to the Roth IRA, we still feel that it is an important tool to consider for your retirement plan. Having a tax-free income source in retirement can give you more flexibility to help you plan for a lifetime of retirement income. Most people have a goal of enjoying their retirement without running out of money. Paying less in taxes over your lifetime reduces your “longevity risk” (running out of money due to a long life). However, now that there is less room for error in Roth Conversions, we feel that anyone considering a Roth Conversion do so with care AND with a Financial Plan. If you want to learn more about creating a Retirement Plan, please call us at (281) 822-8800 or at least download our free Retirement Survival Guide at www.RetirementSurvivalGuide.com.
Disclaimer: Please remember that past performance may not be indicative of future results. Different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment, investment strategy, or product (including the investments and/or investment strategies recommended or undertaken by Avidian Wealth Solutions (“STA”), or any non-investment related content, made reference to directly or indirectly in this newsletter will be profitable, equal any corresponding indicated historical performance level(s), be suitable for your portfolio or individual situation, or prove successful. Due to various factors, including changing market conditions and/or applicable laws, the content may no longer be reflective of current opinions or positions. Moreover, you should not assume that any discussion or information contained in this newsletter serves as the receipt of, or as a substitute for, personalized investment advice from STA. To the extent that a reader has any questions regarding the applicability of any specific issue discussed above to his/her individual situation, he/she is encouraged to consult with the professional advisor of his/her choosing. STA is neither a law firm nor a certified public accounting firm and no portion of the newsletter content should be construed as legal or accounting advice. A copy of the STA’s current written disclosure Brochure discussing our advisory services and fees is available upon request. If you are a STA client, please remember to contact STA, in writing, if there are any changes in your personal/financial situation or investment objectives for the purpose of reviewing/evaluating/revising our previous recommendations and/or services, or if you would like to impose, add, or to modify any reasonable restrictions to our investment advisory services.