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How To Minimize Your Taxes in the The Roth IRA Conversion Strategy

Published on: Mar 20 2022
Estate Planning

*Note: At the end of today’s story (Part 2 on how to convert your traditional IRA to a Roth with minimal tax burden), I highly recommend you take a moment to watch a new video I filmed alongside NFL Hall of Fame quarterback Fran Tarkenton. Meantime, here’s the follow-up to last week’s Retirement Watch Weekly.

Next Step: Reduce your adjusted gross income (AGI).

You’ll find AGI on the first page of Form 1040, on line 11. The deductions you can take from gross income to arrive at AGI are on Schedule 1 of Form 1040.

All the deductions are too numerous to list here, but they include retirement plan contributions for the self-employed, health savings account contributions, medical insurance premiums for the self-employed, and one-half of self-employment taxes.

Review the form to see if you can take or increase any of the deductions.

Next Step: Increase your charitable contributions.

When you’re charitably inclined, increasing contributions for the year can reduce taxable income (when you itemize expenses) and reduce the cost of doing an IRA conversion.

You can bunch several years of charitable contributions in one year by taking the money from savings.

Contributing to a donor-advised fund is a popular way to do this.

Or you can donate an appreciated investment, such as shares of a stock or mutual fund.

This doesn’t require any cash and allows you to deduct the fair market value of the shares without having to pay capital gains taxes on the appreciation that occurred while you owned the property.

Next Step: Pay the conversion taxes from non-IRA funds.

When you take cash out of the IRA to pay taxes on the conversion, you also include that amount in gross income and pay taxes on it.

So, you’re sort of paying taxes on the taxes.

A conversion costs less when the conversion taxes are paid using cash from other accounts on which you already paid taxes.

That also ensures the entire amount taken from the traditional IRA is rolled to the Roth IRA.

You receive a bigger payoff from the conversion by having more tax-free income in the future.

Next Step: Continue to monitor and evaluate your situation.

You might determine early in the year that a conversion doesn’t make sense.

But circumstances can change during the year.

Some people retire or are laid off during the year, causing a substantial drop in gross income.

That might be a good opportunity to convert IRA assets or increase the amount you were planning to convert. Or deductions might increase.

Perhaps you incurred a large amount of deductible medical expenses. Or you decide to make a large charitable contribution that wasn’t planned earlier in the year.

Changes in investment prices also can be a good time to review your decision.

Suppose you planned to do a conversion at some point during the year.

The markets, or one of your investments, suddenly enters a correction or bear market.

Convert the assets before the price recovers and you’ll turn more future ordinary income into tax-free income at the same tax cost.

Or suppose you weren’t planning to do a conversion this year.

A significant market drop could improve the benefits of doing a conversion, because you’ll be able to convert more assets at the same tax cost.

When you expect the prices to recover at some point, this is an opportunity to turn ordinary income into tax-free income at a reduced cost.

You don’t have to convert the same assets. You can sell the assets in the traditional IRA and convert the cash.

After the cash is in the Roth IRA, it can be invested in other assets you believe are more likely to appreciate than the investment you sold.

I’ll cover more on this still-developing topic in an upcoming issue of Retirement Watch Weekly.

P.S. You may remember Fran Tarkenton as the legendary, scrambling quarterback for the Minnesota Vikings, or later as co-host of ABC’s That’s Incredible! But you may not know that Fran has been a leader in the retirement space for two decades now. Recently I sat down with him in his Tarkenton Financial Studios, to talk about the 3 things every retiree must consider right now – especially when there’s an IRA, Roth IRA, or 401(k) at stake. Click here now to watch this urgent new retirement broadcast.

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