It looks like the TCJA will not be sunsetting. That doesn’t make Roth Conversions less appealing, only less urgent.
By John H. Robinson, Financial Planner (November 2024)
Readers of our content know that I do not ever offer up political commentary. Regardless of our readers’ political affiliations, I am guessing that you get enough political op-ed from other sources. I hope our content provides a welcome reprieve from that. Nonetheless, the outcome of the national election earlier this month had implications that are directly and immediately relevant to our clients’ financial plans and cannot be entirely ignored.
While a large segment of the American population was surprised at the Republican Party’s ascendancy, the positive response from the stock market in the ensuing days should be a surprise to no one. The stock market’s surge was not so much an endorsement of the pairing of a Republican president with a Republican Congress as it was an acknowledgment of economic clarity.
The Weighing Machine
Specifically, the election results indicate that there is now near certainty that the Tax Cuts and Jobs Act of 2017 (TCJA) will be extended beyond 2025 and that some provisions may be made permanent. Continued low corporate tax rates translate into greater corporate profits. Continued low personal income taxes translate to more consumer spending. As Warren Buffett eloquently explained, the stock market is not a voting machine but a weighing machine.
This is relevant to our clients because, for the past year or so, I have been encouraging clients to consider filling up their lower marginal tax brackets with partial Roth conversions in 2024 and 2025 in anticipation of TCJA original congressionally mandated expiration date of 12/31/2025. The logic was that a split Congress would help the Democrats achieve their desired goal of ridding blue states of the onerous SALT deduction limit and achieve a desired income tax increase without expending any political capital. As long as the Republicans did not have the votes to extend the TCJA, it would sunset on its own.
While a divided Congress seemed to me to be the most likely outcome of the election, that is not how it played out. However, it is important to note that the election results do not negate the wisdom of Roth conversions. Judicious filling of the 22% and 24% marginal brackets (while being mindful of the potential impact of IRMAA and the Net Investment Income Tax) is still sound planning guidance. It is just not as urgent. Instead of cramming in conversions over the 2024 and 2025 tax years, The TCJA’s new lease on life gives taxpayers more time to take advantage of historically low marginal tax rates.
Roth Conversions Are Not Necessarily Appropriate For Everyone
I am far from alone in advising consumers to consider Roth conversion strategies. News stories, blog posts, and YouTube and TikTok videos extolling the value of partial Roth conversions are ubiquitous on the Internet. One often overlooked problem with this advice is that many consumers do not have the necessary cash on hand in taxable accounts to pay the tax that is due upon the conversion. One under-the-radar alternative strategy for cash-strapped taxpayers who are over age 59 ½ is simply to fill up the lower tax brackets with IRA and/or qualified plan distributions and skip the conversion part. Having tax withheld from the distributions (which you would not do with a Roth conversion) obviates the need to have cash on hand. Consumers who bank their distributions in one year could then use these after-tax savings to pay the tax due on partial Roth Conversions in future tax years.
Additionally, while I continue to hear some Internet “gurus” recommending Roth conversions at marginal tax rates above 24%, I disagree with this advice. The general rule for Roth Conversions is that you should only convert if you believe your future marginal tax rate will be higher than the rate at which you convert. Here are links to two articles on this very topic from Kitces.com.
When A Roth Conversion is Bad Even If Tax Burdens Go up
And here is one more from Ed Slott & Company…
As always, I recommend consulting with your CPA before implementing any investment-related decisions that may have significant tax implications.
John H. Robinson is the owner/founder of Financial Planning Hawaii and Fee-Only Planning Hawaii. He is also a co-founder of fintech software maker Nest Egg Guru and the new personal finance website NestEggPF.com.
