If your clients have been wondering whether it makes sense to convert to a Roth IRA, this might be the year to say yes.
The new tax year delivered a threshold of $400,000 individually and $450,000 for married couples as the threshold for the higher income tax bracket.
It also means they can convert up to $200,000 more into a Roth without crossing the higher-tax-bracket line.
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Because the Bush era tax cuts were made permanent for those under the threshold, it’s no longer necessary to convert as much as possible in one year to lock in a favorable tax rate.
Investors can instead spread their conversion amounts over a period of years. They can even decide to re-characterize their 2012 conversions made in anticipation of higher tax rates as the 2013 dawned.
Re-characterizing basically means undoing a conversion. So if you had $500,000 in your IRA last year and you decided to convert it to a Roth in anticipation of higher tax rates, you could re-charaterize $400,000 of the Roth and put it back into the traditional IRA.
Then you could spread the other $100,000 over the next four years and still not be pushed into the new 39.6% tax rate.
The only caveat is that you have to wait at least 30 days after your conversion to do the re-characterization.
There are other options available now, too, such as spreading the tax liability of a large converted amount over a period of years, making it easier to stomach than having to pay the liability all at once.
Of course, the 3.8% Medicare surtax might come into play, making the original idea of converting still the best option.