Tax Legislation and New Considerations for Roth IRAs

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In the waning days of 2017, Washington D.C. crossed the finish line on a tax bill that GOP leaders have championed since the 2016 election. President Trump signed the sweeping changes to the American tax code into law on December 22, 2017, bringing with it new parameters for taxpayers in addressing their annual deductions and budgeting their income. It may also change the way people save for retirement.

The law’s first order of business was an overhaul of income tax rates for 2018 through 2025. Most income ranges for single individuals, married couples filing either jointly or separately, and heads of households were adjusted and their corresponding tax percentages were lowered. This means a fair percentage of taxpayers may retain more of their paychecks starting this year. However, the 2025 expiration of these reductions have raised concerns among opponents of the law, as eight years tends to represent only a fraction of one’s financial lifetime. You may therefore begin to contemplate the most effective avenue for applying these potentially temporary tax benefits to the marathon of saving for retirement. With a law that provides incentives for paying taxes at new, lower rates and encourages new tax strategies for 2026 and beyond, self-directed retirement plan holders may have a fresh list of reasons to consider a Roth IRA.

Roth IRAs allow plan holders to distribute earnings tax free after five years once they reach age 59½, but they have to pay taxes on their contributions as if the money were still in their personal possession. In other words, Roth IRA holders pay taxes up front for the right to avoid taxes altogether down the road. Conversely, Traditional IRA holders may defer contributions from income and pay taxes on distributions, ideally once they reach retirement age and fall into a lower income bracket. Such account holders may also benefit from the tax law, but only if the redefined tax rates are extended past 2025. Until then, Traditional IRA holders retain the tax-deferred benefits they’ve always enjoyed, while Roth IRA holders may utilize the legislation, seeing it as an opportunity to experience greater tax advantages in the current year. By paying taxes on contributions now—when rates for many will be lower than the last several years—self-directed investors with Roth IRAs can set themselves up for tax-free distributions regardless of what happens in 2026.

These circumstances may give similar credence to Roth conversions, in which pre-tax holdings (i.e. those of a Traditional IRA) are switched to a Roth (or post-tax) status. Any converted funds or assets would be taxed as income just as a distribution would be (early distribution penalties wouldn’t apply), but those same funds or assets could then grow tax free. A sizable converted balance may carry a correspondingly sizable tax burden, but the lower tax rates just signed into law may offer a financially reasonable opportunity to begin yielding tax-free earnings with already successful assets.

This new legislation reminds us that tax law is not static. Will income tax rates go up, down, or stay the same after 2025? The answer is not known, but this current change illustrates the importance of keeping long-term tax strategy in mind as time goes on.

Alternative IRA investments are just as eligible for these activities as stocks or other publicly traded securities, so please don’t hesitate to inquire about your full suite of retirement options. For more information about Roth IRAs, Roth conversions, or self-directed IRA investing in general, please don’t hesitate to contact New Direction IRA.

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