Don't miss this opportunity if taxable income dips [video]
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Here's a missed opportunity that I tend to see every year when reviewing tax returns. Let's say you just filed your return in April and you realize your income was a lot lower than it typically is because of some sort of change. You may be happy that your tax bill was a lot lower, you got a big refund, but you likely had a big missed opportunity as well.
What is a Roth Conversion?
When your taxable income temporarily dips, that's a good time to evaluate Roth Conversions. That's when you take a pre-tax IRA or 401K money and convert it to Roth money. The amount that you convert is taxable income.
Why many people miss out on strategic Roth Conversions
Doing this when your income is much lower than usual or when you even have negative taxable income often makes sense. While people are almost universally on board with this strategy, the problem is you need to be proactive, and that's how a lot of people miss out. You can't file your taxes in April and realize, oh, I should have done a Roth conversion last year. You have to finish the conversion by 12/31 to have that taxable income reported in that year. So you can still do a conversion this year, but it will be reported on this year's tax return, which might not be the best strategy.
Examples of when Roth Conversions Make Sense
Here are a few cases that I see over and over again where this strategy does make sense.
#1) A professional that goes back to school.
They have no income this year, they are paying tuition, they're living off of their cash reserve, their income is the lowest it's been for years and probably the lowest it will be for decades to come. So taking advantage of that dip is smart.
#2) The business owner that just had a rough year.
A lot of deductions, very low income, whatever it is, but it's going to end up being a lot less taxable income than in the past.
#3) Early Retirees
People that retire before Social Security, before RMD's, again, that situation, it just depends. You have to look at it, but there could be an opportunity there in the dip of income to do conversions as well.
Do a tax projection well before year-end.
If you're anticipating any of these situations, or really any reason why you think that your income, your taxable income will be a lot lower this year, make sure you're doing a tax projection at least by August, so you have time to check your calculations just to be clear on how to execute the conversion. And honestly, doing a tax projection every year in August is not a bad habit to get into just to make sure that you are taking advantage of any opportunities that make sense for you by year end.
My name is Linda Rogers, Owner of Planning Within Reach.
Linda Rogers, CFP®, EA, MSBA is the owner and founder of Planning Within Reach, LLC (PWR). Originally from New Jersey, Linda services clients throughout San Diego county and nationwide. She leads the design of PWR's investment portfolios which utilize broad, low-cost investments that integrate environmentally, socially, and governance (ESG) factors.
Planning Within Reach, LLC (PWR) is a fee-only and fiduciary wealth management firm offering one-time comprehensive financial planning, ongoing impact-focused investment management and tax preparation services in San Diego and nationwide. PWR is a woman-owned firm that specializes in busy professionals and impact investors. Planning Within Reach, LLC and their advisors do not receive commissions and do not hold any insurance licenses or brokerage relationships.