That’s significant in the context of retirement savings. A Roth conversion shrinks the size of an estate by the amount of income tax paid on that conversion.
Wealthy individuals can therefore use a Roth account to reduce the size of their taxable estate and potentially avoid federal estate tax, LaBrecque said. A similar concept applies in states that levy an estate tax.
Not just the rich
But Roth accounts may not just benefit the super-rich.
As a presidential candidate, Biden proposed changing the tax treatment of savings in traditional, pre-tax 401(k)s, individual retirement accounts and other retirement accounts.
Savers currently get a tax deduction that rises for those in higher brackets. For example, someone in the 12% bracket would deduct $12 from their taxable income for every $100 of savings; someone in the 37% tax bracket would get a $37 benefit.
If [larger conversions] make sense at 37%, they’ll make more sense at 39.6%.
certified public accountant
That structure would benefit lower earners. (A taxpayer in the 12% tax bracket would get a 20.5% deduction, for example.)
The highest earners would get the equivalent of a 20.5% tax deduction now on their pre-tax savings, but would pay tax at a higher, 37% rate later.
That dynamic means earners in the 22% tax bracket or higher would likely be affected. That would encompass single taxpayers with about $40,500 or more of annual income and married couples who make over $81,000.
That reduced tax break may make Roth accounts more attractive instead, Keebler said.
There are caveats for those who wish to convert a traditional account to a Roth. For one, they need the cash on hand to pay the associated tax on the conversion.
It may also make sense for those doing conversions of modest amounts to wait until the end of 2021, when there’s a little more clarity around changes to tax law, Keebler said. At this point, these are just proposals and may not become law.
Larger conversions may be best accomplished by doing it piecemeal over the year — perhaps split between April, July, October and year-end, Keebler said.
“For larger conversions, if they make sense at 37%, they’ll make more sense at 39.6%,” he said.
Taxpayers should also be aware that a Roth conversion will raise their taxable income and could potentially push them into a higher tax bracket.
There are also income limits on Roth IRA contributions. Taxpayers are barred from making any contributions if their modified adjusted gross income exceeds $140,000 this year. (It’s $208,000 for married joint tax filers.)
Income limits don’t apply to a Roth conversion or 401(k).