Increasing IRA Conversion Benefits after Tax Reform

You can make the IRA conversion opportunity created by tax reform more effective and avoid a new pitfall.

A major change for IRAs is the elimination of recharacterizations, or reversals, for conversions completed after 2017. In the past, the taxpayer could change his or her mind and reverse a conversion through Oct. 15 of the year after the conversion. Usually a conversion would be recharacterized if the value of the Roth IRA declined after the conversion, so the taxpayer wouldn’t be paying taxes on a converted amount that no longer existed.

Now, you have to be more careful about which assets to convert, because you’re locked into paying taxes based on the asset value on the date of the conversion. You don’t want a substantial decline in the Roth IRA’s value soon after the conversion. You also want to avoid being in a situation in which you don’t have the cash to pay the taxes or circumstances change so the conversion doesn’t make as much sense.

One strategy is avoid converting assets that have increased a lot in value or for other reasons seem to be at risk of a sharp decline. Or after the conversion, sell the at-risk assets and invest the proceeds in something less volatile.

Another strategy is to wait until near the end of the year to do a conversion. Don’t wait until the last week of the year. IRA custodians often are inundated with transactions then and
might not complete yours by the end of the year. Some IRA custodians freeze requests for certain transactions after Dec. 20 or so. Consider making the conversion between Thanksgiving and the first couple of weeks of December.

As in the past, many people shouldn’t convert an entire IRA at once.

Instead, convert a portion of a traditional IRA each year for a period of years, known as a serial conversion. A good strategy is to convert enough to bring your taxable income near the top of your tax bracket without pushing you into the next higher bracket.

A conversion is a good estate planning strategy for traditional IRA accounts you don’t expect to need during your lifetime. Convert the amount now into a Roth IRA. Then, name your children or grandchildren as beneficiaries. The lifetime estate and gift tax exemption plus the generation-skipping tax exemption combined with the Roth IRA’s tax-free status make this a completely tax-free gift to the grandchildren. It’s better than leaving them the traditional IRA, because with the conversion you’ve paid the taxes for them. And that gift isn’t counted against your gift tax exemptions.

Another strategy is to help an elderly parent convert a traditional IRA to a Roth IRA. This can be particularly valuable if the parent is forced to take required minimum distributions
(RMDs) that exceed his or her spending needs. The RMDs can push the parent into a higher tax bracket or trigger Stealth Taxes.

You can give the parent money to pay the taxes on the conversion, eliminating RMDs for the rest of the parent’s life. Any remaining value in the Roth IRA passes tax-free to you or whoever else is named as beneficiary.

You can use the annual gift tax exclusion to make a gift of up to $15,000 free of gift taxes without reducing your lifetime estate and gift tax exemption, or spouses jointly can give up to $30,000 tax free. An annual gift exceeding that amount still would be tax free but would reduce your lifetime exemption.