Roth Conversion

Written by Firethorn Wealth Partners

November 18, 2021

Unfortunately, we are witnessing a political ping pong match with the Build Back Better plan. Potential rule changes to the Roth IRA and Roth strategies are back on the table. The House Democrat’s tax bill calls for the elimination of the Roth conversion.
November’s newsletter is going to deal with the What Ifs around the Roth IRA.

After-Tax 401(k) Balances

Some employees or retirees may find an after-tax balance in their 401(k). These are not to be confused with Roth 401(k) balances. After-tax balances in a 401(k) create pretax earnings. These earnings are eventually taxed when they are withdrawn. Currently, anyone can convert that after-tax balance to a Roth IRA or Roth 401(k) account.

There is no tax owed on the conversion, and the earnings now accrue in the Roth account for ultimate tax-free withdrawal. There is no reason not to do the conversion now for anyone that holds a balance in an after-tax account. The potential elimination for all or some investors to convert to Roth creates an incentive to act on this tax strategy now!

Traditional IRA or 401(k) Conversion to Roth

An elimination of the Roth conversion would also shut the door for future backdoor Roth IRA contributions.

Currently, investors that earn over $140,000 for a single filer or $208,000 for joint filers cannot make a direct contribution to a Roth IRA. However, since 2010, there have been no income limits to convert IRA balances to Roth. So, investors that make too money for direct Roth contributions use the backdoor Roth IRA conversion strategy. The first step is for the investor to make a nondeductible contribution to a regular IRA. The second step involves converting that IRA balance to a Roth IRA. Voila, a high-income earner can make a Roth contribution with the extra step of converting that nondeductible IRA balance. 2021 is possibly the last year to act on the strategy, and we would recommend making the IRA contribution and converting to Roth before December 31st even though you can make a 2021 IRA contribution until next April.

In closing, investors need to do three things now. One, convert any after- tax balances in retirement plan accounts. Two, make the 2021 IRA contribution and backdoor it before 12/31/2021. Three, pay very close attention to this political situation as it is very fluid and many other impactful changes are being considered. Please call us to discuss these strategies further as each person’s situation is unique.