July 2022

The Current Economic Times Present Roth IRA Conversion Tax Planning Opportunities for Some

An IRA custodian may now have some IRA owners who are considering converting some of their IRA assets which have deceased in value because of the current economic conditions.

The current investment market is down with many investments being down 10-15%. Some investments are down 20-30% or more.

Many taxpayers are not interested in making a Roth IRA conversion contribution from a traditional IRA, SEP-IRA or SIMPLE-IRA. The reason is, they must include the amount converted in their taxable income for the year. They will have income tax to be paid. It could be in the range of 15%-37%. It is possible a person may have basis within their traditional IRA. The withdrawal of basis. is not required to be included in a person's taxable income. The taxation rules do not allow a person the ability to convert the amount equal to their basis. These rules require a pro-rate rule be applied. For example, a person who has an IRA with a fair market value of $100,000 with basis of $20,000 will included 80% of any distribution amount in income and will exclude from income 20% of any distribution amount.

The taxation rules allow a person the ability to convert a specific investment.

The purpose of this article is to suggest that certain taxpayers should be considering converting those IRA assets which have declined in value if there is a reasonable belief those assets will recover their lost value in the future. A person will be making a bad situation worse if they convert an asset which continues to decrease in value.

For discussion purposes, Jane Roe has an IRA with a total value of $100,000 as of 1/1/2022 as follows:

Under current IRS rules Jane is allowed to convert specific investments. She elects to convert her aggressive investments. The general tax planning rule is - make the conversion at the time an investment has a low value. Since their current value is $20,000 at the time she does the conversion this is the amount she will need to include in income. The assumption is - her tax bracket is 22% . She must pay $4400 with respect to her conversion.

Any increase in the value after the conversion will not be taxable when she or her beneficiary withdraws these funds from her Roth IRA. It is assumed that any future distribution from the Roth IRA is qualified and tax free. If the $20,000 would grow to be $50,000, that $50,000 will be withdrawn tax free.

It may be that the current law could be changed to not allow an IRA owner to convert specific assets, but that is the current law.

Here is another more extreme example.
FMV Current
12/31/21 Value
1. Ultra Conservative $150,000 $150,000
2. Conservative $200,000 $190,000
3. Bitcoin $ 50,000 $ 15,000

Total $400,000 $355,000

Under current IRS rules Jane is allowed to convert specific investments. She elects to convert her Bitcoin investment. The general tax planning rule is - make the conversion at the time an investment has a low value. Since their current value is $15,000 at the time she does the conversion this is the amount she will need to include in income. The assumption is - her tax bracket is 30%. She must pay $4500 with respect to her conversion.

Any increase in the value after the conversion will not be taxable when she or her beneficiary withdraws these funds from her Roth IRA. It is assumed that any future distribution from the Roth IRA will be qualified and tax free. If the $15,000 would grow to be $60,000 (or more) that $60,000 or other amount will be withdrawn tax free.

Some IRA clients may want to convert certain assets because of the tax planning opportunities. Remember, under current law any person with money in a traditional IRA, SEP-IRA or SIMPLE-IRA is eligible to move money from such IRA to a Roth IRA. Even though he person may be extremely wealthy, they are eligible to make a Roth IRA conversion contribution.

© Copyright Collin W. Fritz and Associates, Ltd. “The Pension Specialists”