Tax preparation and tax planning strategies need to be considered when converting a traditional IRA to a Roth IRA. When a taxpayer converts a traditional IRA to a Roth IRA, the taxpayer is increasing his/her taxable income (if no other tax strategies are implemented). Accordingly, we believe that no person should do a Roth conversion without first consulting with his/her tax professional. There are various tax strategies and tax factors to consider when a conversion is done and these need to be carefully considered and analyzed.
Most persons realize that increasing taxable income may trigger some “hidden” tax increases. These unexpected tax increases can include, depending upon the taxpayer’s Adjusted Gross Income (AGI), the loss of itemized deductions and personal exemptions, increased amounts of social security benefits being taxed, and loss of certain tax credits.
Financially secure seniors may wish to do a Roth conversion because they realize that their current tax rate is substantially less than their children’s future tax rates who may be in their peak earnings’ tax years. By doing the Roth conversion, the seniors pay taxes today at their lower rate. If the children (or grandchildren) inherited a traditional IRA, required minimum distributions (RMDs) would be taxed at their children’s higher tax rates. This “family strategy” is used when the seniors do not need the IRA RMDs to sustain their life style and wish to pass on to future generations as much wealth as possible by reducing the taxes paid on those IRA distributions.
While most savvy taxpayers are aware that there are income tax consequences to making the Roth conversion, few are aware that recognizing additional income can also affect the premiums they pay for Medicare Part B insurance. Most Medicare enrollees pay $104.90 a month in 2014 for Medicare Part B, which covers doctors’ bills and certain other items. However, seniors with modified adjusted gross income (MAGI) over $85,000 ($170,000 on joint returns) pay anywhere from $146.90 to $335.70 a month for the same coverage. Does that mean that seniors should not do Roth IRA conversions?
The simple answer to that question is “NO”. The increased Medicare Part B premium is just another example of the need to consider tax preparation and tax planning strategies before making the conversion. An example of a tax planning strategy to mitigate increased income taxes and Medicare Part B premiums is to do an annual series of partial conversions. In other words, rather than doing a complete conversion of a traditional IRA fund in one calendar year, have your tax professional compute the amount of the IRA conversion that could be done over a series of calendar years that would allow you to stay within a stipulated income tax bracket or to avoid the Medicare Part B premium increase.
What if the partial conversion does result in a higher tax bracket than anticipated? One can then implement another tax strategy which is to re-characterize (reverse) just enough of the conversion to get you to the income level desired.
If you want to learn more about your personal tax and financial strategies, we invite you to call 610-594-2601 today to make an appointment at our Exton PA CPA office to discuss your situation. You can also schedule a consultation at Click Here.