Many of today’s planners and accountants are poorly prepared to help their clients through changes in IRA tax and retirement rules, said IRA and tax expert Ed Slott.
That’s because until recent years, long-standing conventional wisdom in tax planning has been to delay taking taxable income or distributions for as long as possible, Slott, president of Ed Slott & Co., said in late June at Financial Advisor’s Next Chapter—ReThinking Retirement virtual conference. Today’s retirement rules and proposed changes in tax laws create greater incentive to take income and pay taxes sooner than later, he said.
“We were trained from the first days of college, hard-wired from our first accounting class, to always defer income, put it off, defer, defer, defer—that was the game,” said Slott. “But when the Roth came out, I became a recovering accountant. I believe in paying taxes at the lowest possible rate. That is how you always end up with more.”
Most people should consider paying income taxes now on assets in their tax-deferred accounts, like traditional IRAs, to convert those assets to a Roth IRA, since taxes are likely to go up in the future, Slott said.
However, others have argued that there is an opportunity cost to taking money out of a tax-deferred retirement account for expenses or to convert it to a Roth IRA, he said.
“But there isn’t, and it can be proven mathematically,” said Slott. “If the effective tax rate now and the effective tax rate later are the same, then the cost is exactly the same. If rates go up, the Roth IRA benefit takes off: It pays to pay some tax now to have more money later, whether you rip the Band-Aid off and do it all or do it partially each year.”
The exception, according to Slott, is if someone will be taxed at a lower rate in the future than they are now. But even if that ends up being the case, clients win a “consolation prize” of being able to take distributions tax-free from their Roth accounts.
Slott urged advisors not to frame Roth IRA conversions in terms of market performance, encouraging conversions after a decline in market performance.
“You can’t time a Roth conversion,” he said. “It’s a long-term proposition, and that’s how advisors have to look at them—a long-term planning vehicle for retirement or even for beyond, for estate planning.”
For married couples, there is even more value in Roth IRA conversions, as any surviving spouse will be faced with the prospect of paying income taxes as a single filer in the future, Slott added.
Converting money out of traditional IRAs has become even more important as a strategy since 2019’s SECURE Act ended most use-cases for the “stretch IRA” estate planning strategy, greatly reducing the value of traditional IRAs as wealth transfer vehicles. Under the stretch IRA strategy, the calculations for required minimum distributions from an inherited IRA could be stretched across a beneficiary’s life expectancy, leading to a lower annual income tax bill.