With just a few weeks to go before the end of 2022, you should consider a partial Roth conversion. The IRS imposes a limit on how much you can contribute to Roth accounts each year and depending on your yearly earnings, you may not qualify to contribute to a Roth IRA. However, there is no limit on the amount of tax-deferred assets that you can convert to Roth each year.
Income taxes are owed on any amount rolled over from a traditional IRA to a Roth, so the best time to make the conversion is when investment values have dropped as they have this year due to negative annual returns for both stocks and bonds in 2022. It is likely not wise to make a full Roth conversion in a single year because it might generate a lot of taxable income that could be taxed at a higher tax rate. However, implementing a partial Roth conversion, or converting a small amount each year, allows for the smoothing of taxable income over as many years possible. There is an upfront tax bill associated with a partial conversion but because the Roth IRA assets will continue to grow tax-free and there is no tax on withdrawals from a Roth IRA, it may be worth considering. You should discuss this with your CPA.
There are four reasons to consider a partial Roth conversion in 2022:
- Your taxable income may be higher in the future. Over-investing in Traditional IRAs and your 401(k) today may increase your overall tax burden and could reduce your after-tax income in retirement.
- Taxes will likely increase. Higher tax rates are likely to have an impact on your after-tax wealth.
- Tax Diversification. A Roth conversion can help you manage your tax burden more proactively.
- Both the Stock and Bond markets are down this year. Because the market is down, you can convert the same share of your IRA for a reduced tax cost.
The most important factor to consider is your tax rate today and how it compares to the tax rate you expect to face in future years when you are making IRA withdrawals. If you suspect you will be in a higher tax rate at some point in the future, you should discuss the partial Roth conversion with your CPA now, before the end of the year.