Has your financial advisor ever lectured you about the wonderfulness of a Roth IRA? Maybe they advised you to convert traditional IRAs into Roth accounts. Sound familiar? Well, now’s the time to do a Roth IRA conversion.

In hindsight, maybe that was a good thing you never got around to a Roth IRA conversion.

Why?

Because for many the financial fallout from the COVID-19 crisis creates a once-in-a-lifetime opportunity to do Roth conversions at an affordable tax cost. It will also give you insurance against future tax rate increases.

Yes. You read that right. You’ll be safe from future tax rate hikes and that’s pretty much guaranteed to happen.

I feel like I’m always telling my clients about retirement contributions and how they can help you save on taxes. I’m a big proponent of investing, saving for the future, and saving taxes now.

But for now, let’s stick to just Roth IRAs.

Roth IRA Advantages

If you’re not familiar with Roth IRAs, let’s review their two big tax advantages.

1. Tax-Free Withdrawals

Unlike withdrawals from a traditional IRA (retirement account), qualified Roth IRA withdrawals are federal-income-tax-free and usually state-income-tax-free, too.

Yes. That’s right.

Withdrawals are tax-free!

That’s advantage number 1!

What is a qualified withdrawal? In general, the tax-free qualified withdrawal is one taken after you meet both of the following requirements:

1. You had at least one Roth IRA open for over five years AND
2. You reached age 59½, became disabled, or died

To meet the five-year requirement, start the clock ticking on the first day of the tax year for which you make your initial contribution to any Roth account. That initial contribution can be a regular annual contribution, or it can be a contribution from converting a traditional IRA into a Roth account.

What’s advantage number 2?

2. Exemption from RMD Rules

Unlike with a traditional IRA, as the original owner of the Roth account, you don’t have to take annual required minimum distributions (RMDs) from the Roth account after reaching age 72. That’s good because RMDs taken from a traditional IRA are taxable.

Under those rules, if your spouse is the only beneficiary of your Roth IRA, he or she can treat the inherited account as his or her own Roth IRA. That means your surviving spouse doesn’t need to withdraw money from the account for as long as he or she would like.

If a non-spouse beneficiary inherits your Roth IRA, he or she can leave it untouched for at least 10 years. As long as an inherited Roth account is kept open, it can keep earning tax-free income and gains. Nice!

Silver Lining for Roth IRA Conversion

Now that you understand the 2 advantages of having a Roth IRA, let’s go into the top 3 reasons why now is the time to do a Roth IRA conversion.

A Roth conversion is treated as a taxable distribution from your traditional IRA. You are essentially receiving a payout from your traditional account with the money then rolling into your new Roth IRA account.

So, doing a conversion will trigger a bigger federal income tax bill for the conversion year. If you have state taxes, that might be bigger, too.  Even with that in consideration, right now might be the best time ever to do a traditional IRA to a Roth IRA conversion.

Here are the top three reasons why.

1. Current tax rates are low

Today’s federal income tax rates might be the lowest you’ll see for the rest of your life.

Yes. You read that correctly. Tax rates are at the lowest they’ve been in over 30 years!

Thanks to the Tax Cuts and Jobs Act (TCJA), rates for 2018-2025 were reduced. The top rate was reduced from 39.6 percent in 2017 to 37 percent for 2018-2025.

However, the time to act is now because the rates that were in effect before the TCJA are scheduled to come back into play for 2026 and beyond.

Rates could go up much sooner than 2026. It all depends on politics and the need to recover some of the trillions of dollars the federal government is dishing out in response to the COVID-19 pandemic.

Believing that rates will only go back to the 2017 levels in the aftermath of the COVID-19 mess might be a little optimistic.

2. Your tax rate this year might be lower due to COVID-19

You won’t be alone if your 2020 income takes a hit from the COVID-19 crisis.

You’ve all seen the news with unemployment rates skyrocketing. You might even be part of that figure.

You also might know first hand that small businesses are hurting as well. PPP loans are in the millions. Spending is down. You get the picture and I’m pretty sure you or someone you know is experiencing the loss of income.

If your income drops, your federal income tax rate for this year might be lower than what you expected just a short time ago. Maybe even way lower. A lower tax rate translates into a lower tax bill if you do a traditional IRA into a Roth IRA conversion this year.

Here’s what to watch out for. If your traditional IRA has a large balance — say, several hundred thousand dollars or more, such a conversion would trigger too much extra taxable income, and you could wind up paying federal income tax at rates of 32, 35, and 37 percent on a big chunk of that extra income.

Just keep in mind the income tax brackets and stay within the lower rates to keep your tax liability on the lower end. Don’t jump to the higher tax brackets because that won’t offer you the tax savings.

This might involve some planning.

You also might only convert some of your traditional IRA to a Roth IRA.

3. A lower IRA balance due = a lower conversion tax bill

Not long ago, the US stock market averages were at all-time highs.

Then the COVID-19 crisis happened, and we watched the averages drop big-time.

Depending on how the money in your traditional IRA was invested, your account might have taken a substantial hit. While nobody likes seeing their IRA balance drop substantially, a lower balance means a lower tax bill when and if you do a traditional IRA to Roth IRA conversion.

When the investments in your Roth account recover, you can eventually withdraw the increased value in the form of federal-income-tax-free qualified Roth IRA withdrawals.

Yes to seeing tax free growth, right?

If you leave your Roth IRA to your heirs (spouse, children, friend, cousin), they can do the same thing.

In contrast, if you keep your money in a traditional IRA account, any value recovery and increase will be treated as high-taxed ordinary income when it is eventually withdrawn in retirement.

As mentioned earlier, the current maximum federal income tax rate is “only” 37 percent. What will it be five years from now? 39.6%? 45%? 50%? 55%? Nobody knows, but we would bet it won’t be lower than 37%.

If you don’t believe me on this, check out this article from the IRS directly.

To Sum it Up

If you do a Roth IRA conversion this year, you will be taxed at today’s “low” rates on the extra income triggered by the conversion.

On the (far bigger) upside, you avoid the potential for higher future tax rates (maybe much higher) on all the post-conversion recovery and future income and gains that will accumulate in your new Roth account.

Remember. Qualified Roth IRA withdrawals taken after age 59½ are 100% federal-income-tax-free, as long as you’ve had at least one Roth IRA account open for more than five years when withdrawals are taken.

I urge you to do some tax planning for this though. Hire a tax professional to help you. You can possibly even talk with your financial advisor about the tax implications. If needed, take 2 years to do the full traditional IRA to Roth IRA conversion. You might only convert some of the traditional IRA to a Roth IRA. It all depends on your personal situation, savings on hand to pay any tax due, and what you’re personally comfortable with doing.

I also urge you not to use the funds from your IRA account to pay your tax bill. This means you’ll need to have a little extra cash on hand to pay the tax liability now. But remember, that tax liability should be way less than later.