5 Considerations for Discounted Roth Conversions

If you’re thinking about a discounted Roth conversion, you’ll want to know its tax implications before moving forward. There are certain considerations to make, and you’ll want to think about timing too. Once you know your options, you’ll be able to decide what’s best for your situation, and when a conversion might make sense.

Consider the following points as you think about a discounted Roth conversion:

1. Understand a Discounted Roth Conversion
If you have investments in an IRA, the contributions you make to it are deducted from your taxable income each year. You’ll pay taxes on the withdrawals when you make them in retirement. For a Roth IRA, the contributions are made with after-tax dollars, and you won’t pay taxes on the earnings or the amounts you take out later. IRAs have required minimum distributions (RMDs), which are amounts that you have to take from your retirement account every year to avoid penalties after age 72. Roth IRAs do not, meaning you can pass on wealth to your loved ones if you choose.

When you convert money from an IRA to a Roth IRA, you’ll have to pay income taxes on the amount you convert from the IRA. Through a discounted Roth conversion, the value of the investments could be reduced, leading to a reduction in taxes, especially if it keeps you from moving into a higher income tax bracket.

2. Know Who Could Benefit from a Discounted Roth Conversion
This strategy is designed for accredited investors with IRAs that are valued at more than $1 million. If you fit into this category, you may want to convert investments into a Roth IRA and be concerned about reducing taxes. Typically, people consider a conversion between the time they retire, starting at about age 55, until the age that required minimum distributions (RMDs) begin for an IRA, which is after age 72 or anytime their income is not filling up a lower taxable bracket.

3. Be Aware of Your Tax Brackets
The power of the discounting Roth conversion strategy shows when you get as many dollars as possible into the 24% bracket, which is just under the biggest jump in the tax code to the 32% bracket. In 2024, couples filing jointly who make up to $364,000 fit into the 24% tax bracket. The 32% bracket includes married couples filing jointly with an income between $364,001 and $462,500. If possible, you might spread the conversions out over several years to manage your tax brackets.

4. Know How You’ll Pay the Taxes
To make the most of a discounted Roth conversion strategy, you’ll want to have cash outside the IRA to pay taxes. This way, you can put as much as possible into the investments at a discounted value so you can maximize their growth potential in the years to come. This might include reviewing the amount you’ll need to pay in taxes and deciding which account to take it from. Taxes should be paid with cash from outside the IRA conversion.

5. Recognize the Discounts Available
You can look into private partnerships, which may provide discounts when doing a Roth conversion. There are other valuation discounts that could be applied to investments, including lack of marketability, minority interest, and lack of control. Working with a tax professional can help you learn of your options and plan for the conversions.

Once you know the impact of a discounted Roth conversion, you could shift investments into accounts that you won’t have to withdraw from until later in retirement, or you could even pass them on to your heirs. If your financial advisor hasn’t brought this topic up during your tax planning meetings, don’t you think it’s time to look for another professional opinion?

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Matthew Chancey is a Registered Representative of Coastal Equities, Inc. and an Investment Advisory Representative of Coastal Investment Advisors, Inc. Neither Coastal Equities, Inc. nor Coastal Investment Advisors, Inc. is affiliated with Micel Financial LLC. Investment Advisory Services are offered through Coastal Investment Advisors, Inc., and securities are offered through Coastal Equities, Inc., Member FINRA/SIPC, 1201 N. Orange St., Suite 729, Wilmington, DE 19801.

Coastal and CoastalOne are trade names for the Coastal Companies. The Coastal Companies are Coastal Equities, Inc., Coastal Investment Advisors, Inc., a US SEC Registered Investment Adviser and Coastal Insurance Services which is made up of several affiliated insurance agencies, co-located at 1201 N. Orange Street, Suite 729, Wilmington DE 19801