Let’s begin with a hypothetical story about our friend, Bob. Last year, Bob, 68, followed a financial influencer touting Roth conversions on TikTok. Bob watched a clip on how a Roth conversion could lead to tax-free growth in retirement and converted his traditional IRA to a Roth. He and his advisor didn’t consult a tax professional. This year, Bob received two unwelcome surprises: a higher-than-expected tax bill and a letter from Social Security stating his Medicare Part B premiums increased. What happened?
Roth conversions move pre-tax retirement funds to after-tax accounts. When Bob converted his traditional IRA to a Roth IRA, he created a taxable event. Bob's large tax bill resulted from the converted amount being taxed as ordinary income. This increased income also triggered the Income-Related Monthly Adjustment Amount (IRMAA). For those near or over 65, a significant conversion may push income above IRMAA thresholds, adding to Medicare Part B and D premiums.
What can we learn from Bob? First, involve all financial professionals: tax and investment. Second, discuss the conversion with them to understand costs, pros, and cons. Third, analyze potential impacts beyond tax, including healthcare costs and Social Security benefits. What may have worked better for Bob? Better communication and phased conversions might have served Bob better.
Roth conversions are not universally appropriate. Individual circumstances like income, tax bracket, and healthcare should be considered. Don't let the allure of tax-free growth overshadow immediate tax obligations and related consequences. Engage your financial team to align your decisions with your goals.
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Wendolyn Forbes is a CERTIFIED FINANCIAL PLANNER™ with Wealth Transition Finance, A Member of Advisory Services Network, LLC. Wendolyn is a fee-only financial planner and member of the National Association of Personal Financial Advisors (NAPFA). CFP Board owns the marks CFP®, CERTIFIED FINANCIAL PLANNER™, and CFP® (with plaque design) in the U.S. This material is provided as a courtesy and for educational purposes only. Advisory Services Network, LLC does not provide tax or legal advice. The information contained herein is general and is not exhaustive by nature. Federal and state laws are complex and constantly changing. Consult your own legal or tax professional for information concerning your individual situation.