A popular retirement savings tactic is on the chopping block in Congress, and investors are eyeing the strategy before it disappears. But there are other things to consider before making changes, financial experts say.
Currently, investors can skirt the income limits for a Roth individual retirement account by using a so-called backdoor maneuver.
Investors can make what’s known as nondeductible contributions to their traditional IRA before converting the funds to their Roth IRA. The future tax-free growth may be appealing if they expect a higher bracket in retirement.
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House Democrats want to crack down on the after-tax backdoor strategy, regardless of income level, after Dec. 31, according to a House Ways and Means Committee summary.
While some investors are eager to complete the move before year-end, advisors urge caution, particularly with legislation in flux.
“It’s one of those things that you can’t look at in a vacuum,” said Marianela Collado, a certified financial planner and CPA at Tobias Financial Advisors in Plantation, Florida, explaining investors need to take a holistic approach.
Cover the tax bill
Roth conversions may trigger levies on pre-tax contributions or earnings, so investors will need a plan for covering the bill.
“You need to be mindful of whatever taxes you’re going to incur, based on the conversion,” said Ashton Lawrence, a CFP with Goldfinch Wealth Management in Greenville, South Carolina.
While Roth IRAs typically offer tax and penalty-free withdrawals anytime for contributions, there is an exception for conversions, known as the “five-year rule.”
Investors must wait five years before they can withdraw converted balances, regardless of their age, or they will incur a 10% penalty. The timeline begins on Jan. 1 on the year of the conversion.
