With the new temporary below-the-line deductions enacted by the OBBBA, taxpayers may now have more planning considerations for Roth conversions. The deduction of focus being the additional below-the-line deduction for seniors (Age 65+) of $6,000 for single filers and $12,000 for married filing jointly. However, this deduction begins to phase out starting at a Modified Adjusted Gross Income (MAGI) of $75,000 for single filers and $150,000 for joint filers.
Roth conversions are ideal when a taxpayer is in a lower marginal tax bracket. The additional senior deduction for taxpayers in the 22% or 24% marginal tax rates may offer a full or partial deduction. These marginal rates can be considered the Roth conversion ‘sweet spot’ as the next marginal tax rate after 24% increases to 32%. Therefore, a Roth conversion at the 24% rate may make sense.
With every Roth conversion, it may be more beneficial to pay the conversion taxes with outside funds rather than from the conversion itself. The tricky part here with the new deduction is that while you may be at a marginal tax rate of 22%, your effective tax rate (how much you pay in total tax relative to your taxable income) increases as the deduction phases out.
With the conversion, AGI increases, reducing the deduction, thus increasing the effective tax rate. So, while a taxpayer may remain in the 22% marginal tax bracket, their effective tax rate on the amount converted could be higher.
The end goal of a Roth conversion is to pay the taxes now at a lower tax rate than what’s anticipated in the future. When dealing with Roth conversions it is advisable to seek professional tax advice.