Unlocking the Power of Roth: Strategies in a Changing Landscape

Brandon Day, Chief Market Strategist • Nov 01, 2023
Introduced in 1998, Roth IRAs became a popular financial instrument. Yet, for many high-income earners, Roth contributions were beyond reach due to income limitations. Everything changed in 2010 when the income ceiling for Roth conversions was removed, sparking the evolution of Roth conversion strategies. Today, the political landscape is shifting, with the recent Build Back Better agenda in the House proposing a reinstatement of income limitations. While its fate in the Senate is undetermined, one thing is clear: those seeking to leverage these strategies should act before the legislative window closes.

The Value of a Roth IRA in Retirement

A Roth IRA isn’t just another retirement account. It’s a potent financial tool. If you find yourself facing higher taxes or unforeseen expenses, a Roth IRA provides an effective tax buffer and a resource that doesn’t affect your AGI. Further, if you anticipate your Required Minimum Distributions (RMDs) surpassing your needs, moving funds from an IRA/401k to a Roth can lower future RMDs—thanks to Roths being exempt from RMD rules.

1. The Back Door Roth Strategy
For high earners restricted from direct Roth IRA contributions, the Back Door Roth emerges as an ingenious strategy. Here's the beauty of it: while direct contributions have income limits, conversions currently don’t.

Key Steps & Considerations:
Have an existing pre-tax IRA? Think about a Roth Conversion. Why? All IRAs with pre-tax funds play into the 'exclusion ratio' calculation during a Roth conversion year. This can complicate the strategy's benefit clarity.
Typical steps:
Open a Traditional IRA.
Contribute the maximum ($6k).
Promptly convert this IRA to a Roth (either an existing one or a new one).

Important: You will NOT deduct the IRA contribution from your taxes. If there’s no growth and it’s not pre-tax, the conversion to Roth remains tax-free.

2. The Mega Roth Conversion
Thanks to the Tax Cuts and Jobs Act of 2017, many enjoyed the most favorable tax brackets of their lives. But with some provisions expiring in 2023 and the rest in 2025, there's a timely opportunity. Considering a substantial conversion from your IRA to Roth? It might be wise to do so in these favorable tax conditions. The Mega Roth Conversion usually involves substantial sums, and with inevitable taxes on our 401k and IRA accounts looming, it poses the question: Is it wise to pay some now?

Key Considerations:
- Expecting a year of lower income?
- Can you reduce your income further, perhaps by maximizing retirement contributions or adding to a Deferred Compensation plan?
- Got the cash reserves for the taxes from the Roth Conversion? It’s essential not to use the conversion amount for these taxes; use non-retirement funds instead.
- It's usually best to gauge your AGI for the year, ensuring your conversion doesn't push you into an unexpected tax bracket. Many opt for Mega Roth Conversions in the 4th quarter for a clearer picture of taxable income.
-In the ever-evolving world of finance, agility is key. Whether considering the Back Door or Mega Roth strategies, staying informed and proactive will position you advantageously for the future.



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