As the calendar year draws to a close, individuals focusing on their retirement plans may contemplate the benefits of Roth Individual Retirement Account (IRA) conversions. While this financial strategy holds the allure of tax-free growth in the future, it is essential to understand the complexities it introduces to your current tax situation. Although converting pretax or nondeductible IRA funds into a Roth IRA may seem advantageous, the reality is that it significantly increases your current-year adjusted gross income (AGI) and can trigger a series of unintended tax ramifications.
Roth IRA conversions typically allow contributors to transfer funds from a traditional IRA into a Roth IRA. This maneuver is particularly appealing because any growth from this point forward occurs free of federal taxes. However, it is crucial to recognize that the total amount converted counts towards your AGI in the year of conversion. This increase in AGI may inadvertently push your income into a higher tax bracket or eliminate your eligibility for certain tax credits and deductions. Experts warn that individuals should maintain a vigilant awareness of their AGI throughout the year to avoid nasty surprises come tax season.
JoAnn May, a certified financial planner and CPA, emphasizes how elevating one’s AGI can lead to “completely unintended” consequences. For instance, social security beneficiaries could find themselves subject to federal income taxes on as much as 85% of their benefits once their AGI crosses particular thresholds. Furthermore, the medical expense deduction becomes increasingly difficult to claim as AGI rises. In 2024, individuals can only deduct unreimbursed medical expenses that exceed 7.5% of their AGI if they decide to itemize their tax breaks.
Individuals should also keep an eye on the implications regarding Medicare. If you are approaching the eligibility age or are already enrolled, a higher AGI made through a Roth conversion could influence your income-related monthly adjustment amounts (IRMAA), which affect Part B and Part D premiums of Medicare. The income used for determining IRMAA includes your modified adjusted gross income (MAGI)—your AGI plus any tax-exempt interest—for the 2024 premiums based on 2022 income. As such, a Roth conversion might inadvertently escalate your premiums for potentially two years down the line.
In 2024, the standard monthly Medicare Part B premium is set at $174.70. However, this could increase considerably should your MAGI exceed specific thresholds—$103,000 for individuals and $206,000 for married couples. The repercussions of going over these thresholds can be extreme, as even a seemingly nominal increase in income could lead to significantly higher premiums. Financial experts warn against the pitfalls of narrowly surpassing these limits. For example, “The last thing you want is to peak right over that bracket by $1,” said Ashton Lawrence, a certified financial planner, stressing the potential for steep premium increases.
Beyond the impacts on Medicare, your AGI can also affect eligibility for health insurance tax credits through the Affordable Care Act marketplaces. Currently enhanced through 2025, nearly 92% of enrollees could benefit from these credits, which average annual premium reductions of about $700. However, watchful management of AGI is crucial, as surpassing necessary thresholds could lead to a reduction or outright elimination of these advantageous credits.
As the year-end approaches, contemplation of Roth conversions may be paramount for many seeking retirement savings. However, an informed decision requires a holistic understanding of the interplay between income, AGI, and its ripple effects across various tax implications. Individuals must carefully evaluate their financial landscape and consider consulting with financial professionals to navigate these complexities effectively.
While Roth IRA conversions can stream into tax-free growth in the future, the immediate effects on AGI can be multifaceted and consequential. Hence, proper planning and awareness of the associated risks are vital to maximizing retirement income without falling victim to unforeseen tax liabilities.