The entire theory behind a retirement account is that you get a tax deduction in your income-earning years. Then, when you take the money out of the retirement plan, you should be in a lower tax bracket. However, with tax brackets being the lowest in modern history, it may make sense to convert a traditional IRA to a Roth and pay less now.
Roth IRAs are not tax-deductible. You can put up to $5,500 into the plan ($6,500 if age 50 or older).
For 2018, eligibility to make annual Roth contributions is phased out between modified adjusted gross income (MAGI) of $120,000 and $135,000 for unmarried individuals. For 2019, the phase-out range is $122,000 to $137,000. For married joint filers, the 2018 phase-out range is between MAGI of $189,000 and $199,000. For 2019, it is $193,000 to $203,000. If your MAGI is more than these phase-out limitations, you can do a few things.
If you contribute to a 401k plan at work, you can earmark your contributions to the plan as Roth contributions. These do not have MAGI phase-out requirements. In 2019, you can contribute $19,000 to a Roth through your 401k at work. If you are age 50 or older, you can contribute an additional $6,000, for a total of $25,000.
The big deal with a Roth IRA is that while you don’t get a tax deduction for your contributions, if you leave the money there for five years and wait to withdrawal any until you are age 59½ , there is no tax paid upon withdrawal. Further, when you reach age 70 ½ you are not required to take required minimum distributions (RMD) from the plan. In effect, you can leave the money in your plan, and upon your death, it will be distributed to your beneficiaries. In addition, it grows tax-free the entire time it is in the Roth IRA.
For 2019, the tax brackets are as follows:
Marginal Tax Rate
Married Filing Joint
Head of Household
Married Filing Separate
$0 - $9,700
$0 - $19,400
$0 - $13,850
$0 - $9,700
$9,701 - $39,475
A way to circumvent this tax is through a “Backdoor Roth Conversion.” If you make a contribution to a non-deductible IRA, within a very short time (i.e. a day, week, month or two months), you can convert the non-deductible IRA to a Roth. The only tax that will be due is on the money made while in the non-deductible IRA. The shorter you leave the money in the traditional IRA, the less the tax will be. The deductibility of a contribution to a traditional IRA phases out due to MAGI limitations and whether or not the taxpayer or spouse is converted by a plan at work. However, taxpayers still contribute to non-deductible IRAs. The problem is that the earnings are taxed upon distribution. Not to mention, at age 70½, there is a penalty for not taking an RMD.When you convert, you must pay a tax on it. For example, if you convert $25,000 from a traditional IRA to a Roth, the full amount is taxable.For example, if you have a taxpayer who is married filing jointly, and their income is $50,000. They can convert a traditional IRA to a Roth in the amount of $28,950 and still remain in the same tax bracket. It might make sense for the conversion to happen.
As you can see, there are many reasons to convert a traditional IRA to a Roth with the lower tax rates imposed by the TCJA.
Craig W. Smalley, MST, EA, has been in practice since 1994. He has been admitted to practice before the IRS as an enrolled agent and has a master's in taxation. He is well-versed in US tax law and US Tax Court cases. He specializes in taxation, entity structuring and restructuring, corporations, partnerships, and individual taxation, as well as...