facebook twitter instagram linkedin google youtube vimeo tumblr yelp rss email podcast phone blog external search brokercheck brokercheck Play Pause
Military Finances 301: Is Now the Time for Roth Conversions? Thumbnail

Military Finances 301: Is Now the Time for Roth Conversions?

Retirement Funding Taxes

One upside of a down market is the ability to do a Roth conversion on sale. Here is the concept. You've decided that it is in your best interest to do Roth conversions ("withdrawing' money from a Traditional IRA and depositing the funds in a Roth IRA). On the first of the year your Traditional IRA has a balance of $100,000 and you determine that the right amount for you to convert is $20,000. If you convert at the beginning of the year, you'll convert 20% of your Traditional IRA balance. But let's say instead you delay the actual conversion until later in the year. Let's also assume that the value of your Traditional IRA declines to $80,000 (not too hard to imagine this year). If you convert the $20,000 after the decline, you'll convert 25% of the balance and more of your future growth will be tax free (theoretically).

That's the idea. But does that mean you should do Roth conversions now?

Factors to Consider Before a doing a Roth Conversion

Just because you can do something doesn't mean you should. You'll want to make sure the Roth conversion makes sense.

Let's start with tax rates. If your tax rate will be the same when you're retired, retired then converting now (and paying the taxes due with IRA funds) or leaving the funds in the Traditional IRA will put the same amount of money in your pocket in retirement. If your tax rate will be lower in retirement, the conversion may not be in your best interest. If your tax rate will be higher in retirement, then the Roth conversion becomes more compelling.

But that isn't the end of the tax discussion. If you're going to retire to a state without an income tax and you currently live in a state that has an income tax, then the likelihood that your combined tax rate in retirement will be lower than it is now is low. Think about it. If you live in VA, you will pay 5.75% on the converted amount. If your Federal marginal tax rate is 24%, it would need to increase by almost 25% (5.75/24), for it to exceed what you'll pay on the conversion. If the converse applies (you don't have a state income tax now and you will in retirement), then the Roth conversion starts to look pretty good. If you're still on Active Duty, this scenario could easily apply to you.

You'll also want to look at other "taxes". The biggest one is what's called IRMAA (Income Related Monthly Adjusted Amount). This is the amount your Medicare premiums increase due to your income (Adjusted Gross Income (AGI) to be precise). Since money taken out of your Roth IRA isn't included in AGI it won't affect whether you pay IRMMA. IRMAA isn't something to scoff. It starts at about $170 per month (per person on Medicare) and tops out at $578 per month. IRMAA kicks in at $91,000 for single taxpayers and $182,000 for those who filed jointly. This is one place in the tax code where one more dollar of income can cost you more than $1 in "taxes". Hit $91,001 or $182,001 in AGI and your Medicare premium goes up $2,041 per person for the year. If you have a lot of money in pre-tax retirement accounts, you could hit the IRMAA threshold pretty easily when Required Minimum Distributions start...especially when combined with a military retirement and Social Security.

Roth conversions can also help reduce the amount of Social Security that is subject to income tax. For military retirees, this probably isn't a concern.

Other Things to Consider

A dollar in a Roth IRA is likely more valuable than a dollar anywhere else. So, if you can, pay the taxes on the conversion with non-IRA funds. This is an excellent use for cash you have sitting on the sidelines.

If you have basis in your IRA, consider transferring the pre-tax dollars to an employer sponsored plan (401(k), 403(b), TSP) and convert the basis only. That way there won't be any taxes and all future growth on those after-tax dollars will be tax-free.

If you're not sure which direction the market is heading (and even if you think you do know where it is heading in the short-term, you probably don't), you can do the equivalent of dollar cost averaging and convert a portion of your target every month. You'll mitigate some of the risk that the market continues to decline.

Military Finances are Different

From choosing the state where you reside to having tax-free income (on active duty and potentially in retirement), military finances are different. That's why we think you should work with a financial advisor or planner who deals with current and retired military officers and NCOs each and every day. If you'd like to see how we do things, schedule a free initial consultation using the button below.

If you found this article useful, you might like the following blog posts:

Military Finances 101: Should I Use My Roth IRA as an Emergency Fund?

Retired Military Finances 401: The Widow(er)'s Penalty

Military Tax Benefit: Rollover of SGLI Proceeds to a Roth IRA

Please remember that past performance may not be indicative of future results. Different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment, investment strategy, or product (including the investments and/or investment strategies recommended or undertaken by C.L. Sheldon & Company, LLC ), or any non-investment related content, made reference to directly or indirectly in this blog will be profitable, equal any corresponding indicated historical performance level(s), be suitable for your portfolio or individual situation, or prove successful. Due to various factors, including changing market conditions and/or applicable laws, the content may no longer be reflective of current opinions or positions. C.L. Sheldon & Company, LLC does not make any representations or warranties as to the accuracy, timeliness, suitability, completeness, or relevance of any information prepared by any unaffiliated third party, whether linked to C.L. Sheldon & Company, LLC website or incorporated herein, and C.L. Sheldon & Company, LLC takes no responsibility therefore. All such information is provided solely for convenience, educational, and informational purposes only and all users thereof should be guided accordingly. Moreover, you should not assume that any discussion or information contained in this blog serves as the receipt of, or as a substitute for, personalized investment advice from C.L. Sheldon & Company, LLC . To the extent that a reader has any questions regarding the applicability of any specific issue discussed above to his/her individual situation, he/she is encouraged to consult with the professional advisor of his/her choosing. C.L. Sheldon & Company, LLC is neither a law firm nor a certified public accounting firm and no portion of the blog content should be construed as legal or accounting advice. A copy of the C.L. Sheldon & Company, LLC ’s current written disclosure statement discussing our advisory services and fees is available for review upon request. DISCLAIMER OF TAX ADVICE: Any discussion contained herein cannot be considered to be tax advice. Actual tax advice would require a detailed and careful analysis of the facts and applicable law, which we expect would be time consuming and costly. We have not made and have not been asked to make that type of analysis in connection with any advice given in this blog post. As a result, we are required to advise you that any Federal tax advice rendered in this blog is not intended or written to be used and cannot be used for the purpose of avoiding penalties that may be imposed by the IRS. In the event you would like us to perform the type of analysis that is necessary for us to provide an opinion, that does not require the above disclaimer, as always, please feel free to contact us.