Retirement. The word conjures images of leisurely days, endless travel, and the freedom to pursue long-held passions. However, the reality of planning for this pivotal life stage often falls far short of the idyllic picture. The actual exercise of retirement planning is a complex and nuanced endeavor, riddled with uncertainties that can make pinpointing the right strategy seem like navigating a dense fog rather than following a straightforward path.

One retirement planning strategy that has gained traction is the Roth conversion. While Roth conversions have been allowed for some individuals since the passage of the Taxpayer Relief Act of 1997, the prior income limitation of $100,000 was not eliminated until 2010, making Roth conversion benefits available to all IRA investors.

In an article in the October 2024 edition of Investment Perspectives, retirement plan expert Holly Ferguson explored various strategies for backdoor Roth conversions, offering guidance for individuals who still face income limitations that would otherwise prevent them from contributing directly to a Roth IRA or Roth 401(k) plan.

Understanding the Basics

Traditional IRAs, first introduced in 1974, provide a benefit by offering tax deductions on eligible contributions and a tax deferral until the withdrawal window begins. However, during retirement, nearly all withdrawals from a traditional IRA are subject to ordinary income tax, which could potentially increase your overall tax liability, especially when Required Minimum Distributions (RMDs) begin. The current age at which to start taking RMDs is 73.

On the other hand, Roth IRAs do not provide an upfront tax deduction on contributions, but qualified withdrawals in retirement are generally tax-free. A Roth conversion allows you to transfer cash or assets from a traditional IRA to a Roth IRA, changing the tax treatment of future earnings and distributions on converted amounts. While this strategy involves paying taxes on the converted amount in the tax year converted, it offers the potential for substantial tax savings during retirement, especially for those in higher tax brackets.

A New Landscape for Planning: The Secure Act and Secure Act 2.0

The Secure Act and its successor, the Secure Act 2.0, introduced two significant changes that impacted the administration of and planning around IRAs:

Delayed Required Minimum Distributions (RMDs): In 2019, the Secure Act initially increased the Required Beginning Date (RBD), more commonly known as the age to begin RMDs, from 70 ½ to 72. Then, when the Secure Act 2.0 passed in 2022, it offered another increase to the RBD to age 75 beginning in 2033. These delays give investors more time for their retirement savings to grow.

Inherited IRA Rules: The most significant change introduced by the Secure Act in 2019 materially altered the rules for inheriting IRAs, particularly for non-spouse beneficiaries. Before its enactment, many beneficiaries could stretch out RMDs over their lifespans, effectively extending the tax benefits of the IRA. The Secure Act introduced a 10-year rule for most non-spouse beneficiaries, requiring that the entire balance of an inherited IRA be withdrawn within 10 years of the original owner’s death. This 10-year rule eliminated the “stretch IRA” strategy for most non-spouse beneficiaries, potentially resulting in higher tax burdens and forcing them to withdraw taxable distributions more quickly than the original owner planned. Secure 2.0 and subsequent guidance from the IRS carved out exceptions for younger spouses, minor children, and disabled beneficiaries to mitigate the impact of these sweeping changes.

With these new rules in place, the Secure Act and Secure Act 2.0 have significantly reshaped the landscape of IRA planning. Consequently, individuals should revisit their retirement and estate plans to assess how these changes may impact their retirement planning and wealth-transfer strategies involving IRAs.

Roth Conversions: Is This Strategy Right for Me?

Retirement planning is a multifaceted journey, and achieving a secure and fulfilling future requires careful consideration of various factors.

Roth conversions offer one path to unlocking tax-free growth and withdrawals in retirement. Understanding the intricacies of Roth conversions in a post-Secure Act world is crucial. They involve immediate tax consequences and may add another layer of complexity due to the possible impact on Medicare premiums and Social Security.

If you are considering a Roth conversion strategy as part of your retirement or estate plan, it is essential to seek guidance from a qualified adviser.

Your TCO or tax adviser can play a vital role in this process. Analyzing a Roth conversion’s potential benefits and drawbacks can help you develop a tailored plan that complements your retirement or estate planning needs. Whether your goal is maximizing tax-free income in retirement, minimizing future tax burdens on withdrawals, or ensuring a more secure financial future for your loved ones, do not embark on this journey alone. Your TCO or tax adviser will support and empower you to navigate the post-Secure Act landscape to confidently evaluate and implement Roth conversion strategies, increasing your chances of achieving a secure and fulfilling retirement with a lower tax burden.