As we get to the end of the year, and you have a better idea of your taxable income for 2019, remember to consider a mini-Roth conversion. What I mean by this is to look at making sure you are taking advantage of the whole 12% bracket. This is much more likely to be useful for married taxpayers since they can have taxable income after deductions of $78,950. If you add in the standard deduction of $24,400, you can have taxable income of just over $103,000 and still be in the 12% bracket! For single taxpayers, using the standard deduction, you can have taxable income of just over $51,000 at the top of the 12% bracket.
That rate is very generous and I don’t know how long it will last. If your income isn’t over those numbers, you should look at topping it off by converting part of your traditional or rollover IRA’s into a Roth IRA. For example, a married couple with $70,000 of taxable income before deductions could convert about $30,000 into a Roth and still stay in the 12% bracket. Later, if rates are higher, they would have tax free money they could pull out, having already paid taxes at that low rate of 12%, essentially locking it in.
Of course there are caveats, and the normal Roth IRA rules about withdrawals do apply. Additionally, there is the 5 year waiting period after a conversion before you can pull out your principal without penalty. This waiting period is waived if you are over 59.5 years of age. For younger investors looking to spend retirement money earlier than 59.5, this does create an interesting opportunity.
Let’s take the example of someone who is 40 years old and is looking to retire at 50. If they have accumulated significant traditional IRA savings, touching that money before 59.5 without penalty is a nuisance. If we continue our example of the couple who has $70,000 of taxable income before deductions, they could start converting $30,000 per year into a Roth IRA from the age of 40 to 50. By the time they got to age 50, they would have $300,000 of principal in their Roth. Of that, about half of it would be accessible without taxes or penalty, and another $30,000 would come available each year until they got to 59.5, where the remaining balance would be accessible tax free. They would be bypassing the 10% penalty rule in essence, and that money would have only been taxed at 12%, a pretty sweet deal!
As always, make sure to consult with your tax professional before starting this, but the deadline is December 31st for this tax year to start that 5 year rule ticking, so it’s time to start thinking about it. It’s also probably a good idea to get it done by December 15th to make sure there’s time for paperwork etc.