Stephen Kelley

Question: Do you believe taxes will be going up or down in the future? Before answering, consider this. Marginal tax rates are currently at a near historical low. At the same time, budget deficits and national debt are at an unquestioned historical high. As you read this, the national debt is at a record $27 trillion, and going up. In the past year alone, it’s risen by over $3 trillion, and will most likely go up that much again next year, whoever wins the election.

Notorious bank robber, Willie Sutton, is famous for saying, when asked why he robbed banks, “because that’s where the money is.” So, if robbers rob banks because that’s where the money is, where does Congress look to tax? Who has the money?

In a word, you. It’s estimated that there is currently over $19 trillion of untaxed money sitting in defined contribution retirement accounts. (source: https://www.statista.com/statistics/940498/assets-retirement-plans-by-type-usa/) That’s actual money that must be taxed before it’s spent. Do you believe Congress is aware of that? Do you believe that makes you and your retirement accounts a likely target for future taxation? If so, what are you doing about it?

Here’s another thing to consider since we’re on the topic. Are these accounts at historic lows or historic highs? Is the market currently way up, or is it way down?

So, looking at all this, it seems we have the makings of a perfect tax storm. Record high markets supporting and unprecedented amount of untaxed retirement dollars that will need to be taxed and spent over the next several years, during a time of unprecedented low tax rates that will, by law, be disappearing at the end of 2025. All mixed together in a cauldron of record unemployment, business failures, bankruptcies and economic uncertainty stoked by an unrelenting pandemic that is spiking yet again.

Putting all this together, what does that suggest? To me, it suggests an unprecedented and fleeting opportunity to cash in on something you rarely see: an economic certainty: markets are at record highs and taxes at near record lows, with a six-year window to take advantage of the situation.

Here’s how you can use this to your advantage: Move your money out of taxable IRAs, 401(k)s, etc., and into Roth accounts. Caution, however. There is no discernable downside if this is done properly, but all kinds of peril if done improperly. Here are the things you must consider when looking to convert.

There is no limit on the amount of money that can be converted to a Roth IRA. Unlike the initial contributions which are limited by income levels and maximum amounts per year, conversions are not restricted.

There is a limited window of time to take advantage of tax rates we may never see again, ending no later than the end of 2025 when the Tax Cut and Jobs Act sunsets. Consider for a moment that act was passed by a Republican Congress and signed by a Republican president. Why would they not have made it permanent? Because even they recognized it was unsustainable. So, they gave us a short window of time to secure the lowest rates in many decades. After that, all bets are off, and my hunch is that Congress will aggressively come after your retirement accounts at that time. Even if that turns out not to be true, we know rates will not go down, so there seems to be little if anything to lose by acting on it now.

The main pitfall that can submarine a Roth rollover is if the market loses value after you roll the money over. For example, assume you have $100,000 in IRAs you want to rollover by the end of this year, and then next year the value of your stocks goes down, say 20%. You paid taxes on $100k, but only have $80k tax free to show for it. In the past, IRS allowed you to recharacterize these scenarios if done prior to October of the following year, but that went away in the Tax Cut and Jobs Act. So now, if you are converting to a Roth, you must do so with safe money accounts or run the risk of paying taxes on money you no longer have.

That can become somewhat unappetizing when the market could still go up. So how do you manage that? We recommend using accounts that are indexed to the stock market rather than being in the market. The difference is indexed accounts can go up with the market, but will lock in losses when the market is down. So, if the market goes up, your newly minted Roth account will go up with it, but if the market sinks, your newly converted assets are protected, and you won’t end up paying taxes on funds you no longer possess.

Some of these indexed accounts also provide deposit bonuses that can be used to offset the most of the conversion taxes. And, as time goes on, if the market does crash, since your principal is protected, you can then take advantage of market recoveries with the full amount you started with, using tax-free dollars. How can it possibly get any better?

But be clear. You have a limited window to do this. And it gets shorter every year, with the first deadline coming in just over two months. So, if this is a strategy you think you would like to explore, you must begin now, or you will start to lose significant opportunities for savings in the very near future.

Stephen Kelley is a recognized leader in retirement income planning. Located in Nashua, NH, he services Greater Boston and the New England areas. He is author of five books, including “Tell Me When You’re Going to Die and I’ll Tell You How Well You Can Live,” which deals with the problem that unknown lifespans create for retirement planning. It and his other books are available on Amazon.com. His radio program, The Free Money Guys, can be heard every Sunday at noon on WCAP. He also conducts planning workshops at his New England Adult Learning Center, located in Nashua. Initial consultations are always free. You can reach Steve at 603-881-8811 or at www.FreeToRetireRadio.com.

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