Does It Matter Which Spouse Converts Their Traditional IRA to a Roth IRA?
BY: Joan Koss, MBA, CFP®, ChFC®, FSCP®, LUTCF®
Converting a traditional IRA to a Roth IRA is a popular strategy for many individuals looking to increase their retirement savings and take advantage of tax-free withdrawals in retirement. However, for married couples, the question arises as to whether it matters which spouse makes the conversion.
Generally, we have found, using holistic financial analysis tools, that it produces better long-term outcomes when the older spouse implements conversions, due to the interplay of the IRS Uniform Lifetime Table for Required Minimum Distributions (RMDs) for a surviving spouse. That said, in this article, we will explore other factors that couples should consider when deciding which spouse will convert their traditional IRA to a Roth IRA.
Income Tax Implications
The first and most important factor to consider is the income tax implications of the conversion, as well as the tax filing status of the married couple. When a traditional IRA is converted to a Roth IRA, the conversion amount is included in the converting spouse’s taxable income for the year of the conversion. Assuming the married couple is filing their taxes jointly, this means the couple will be jointly responsible for paying taxes on the conversion amount at their marginal tax rate.
It really makes no difference if one spouse has a higher income or is in a higher tax bracket than the other unless the married couple is filing their taxes separately. In that case, it may be more beneficial for the other spouse with a lower income to make the conversion. By having the spouse with a lower income make the conversion, married couples who file their taxes separately may attain a lower, overall, effective tax bill.
Retirement Savings
Another factor to consider is the individual retirement savings of each spouse. Suppose one spouse has significantly more savings in a traditional IRA than the other. In that case, it may make more sense for them to make the conversion to allow the couple, as a whole, to maintain greater flexibility in having different types of taxable accounts.
For example, taxable or non-qualified accounts allow for the return of cost basis before incurring capital gains taxes when making withdrawals; traditional IRAs allow for tax-deferred growth and are the type of account used to make qualified charitable distributions (QCDs). Finally, Roth IRAs take advantage of tax-free withdrawals in retirement.
Roth IRAs are especially beneficial if the couple expects to be in a higher tax bracket in retirement. So having different types of taxable accounts allows each spouse to make tax-efficient withdrawal decisions, individually and/or as a couple, to meet their income needs and/or gifting goals.
State Income Taxes
State income tax considerations can also play a key role. As just one example: Colorado offers a deduction of up to $24,000 for “pension/annuity” income for people age 65+ ($20,000 for people age 55-64). “Pension/annuity income” includes Roth conversions and other distributions from tax-deferred accounts. And this deduction operates on a per-person basis.
So, if a married couple (both age 65+ for our example) collectively want to convert $60,000 from tax-deferred accounts this year, and they have no pension/annuity income this year other than this intended conversion, they could each convert $30,000. That would mean only $6,000 for each of them ($12,000 in total) would be taxable at the state level. In contrast, if they did $60,000 from one spouse’s traditional IRA balance, $36,000 would be taxable at the state level.[1]
So reviewing any relevant tax issues associated with a particular state will be essential for married couples.
Years of Higher and Lower Income
Additionally, as noted above, one of the most important considerations is the age of each spouse. Married couples will regularly want to look at their combined income picture to determine if there are years when they will have higher or lower income where planning decisions such as Roth conversions, charitable donations, and/or other strategic asset transfers can take place.
For many clients, there will often be some “gap” years after they retire and before they are subject to RMDs, where they will be in lower tax brackets and where significant tax planning can be done. This is true, now more than ever, with the passage of the SECURE Act 2.0, which pushed RMDs for some out as far as age 75.
Income Limits
It’s also helpful to keep in mind that while the income limit to implement Roth conversions was eliminated in 2010, there are still income limits for Roth IRA contributions. In that case, a “backdoor Roth conversion IRA” could allow one or both spouses to take advantage of getting more dollars into a Roth IRA without paying any taxes. (This can be true for after-tax contributions in a 401(k) plan too).
To be clear, any existing traditional IRA(s) a spouse may own with pre-tax dollars would have to be converted to a Roth IRA first, before implementing the backdoor Roth strategy. However, for a spouse without a traditional IRA, a backdoor Roth contribution can be made as long as the couple, as a whole, has earned income equivalent to the contribution limit. There also is no age limit on making regular contributions to traditional or Roth IRAs as of 2020.[2]
SECURE Act 2.0
The SECURE Act 2.0 also has included some new provisions for SEP Roth IRAs, as well as allowing individuals to transfer up to $35,000 of 529 plan account balances that have been open for at least 15 years into a Roth IRA.
So if a spouse has consulting income and/or plans to possibly move into phased retirement with self-employed income, and/or has excess savings in a 529 plan (or the ability to make 529 plan contributions with a longer life expectancy), then it may be more beneficial for one or both spouses to implement these types of strategies to take advantage of the tax-free withdrawals from Roth IRAs later in retirement, which could result in significant savings.
Consulting with a Financial Advisor
Finally, it’s important to keep in mind that converting a traditional IRA to a Roth IRA is a big decision and should be made after careful consideration and consultation with a financial advisor or tax professional.
With taxes potentially set to rise in the future under the 10-year sunset provision of the Tax Cuts and Jobs Act passed in December 2017, as well as the new “drain-in-ten” rules for beneficiaries of inherited traditional IRAs and qualified plans under the SECURE Act, systematic Roth conversions can help optimize a married couple’s wealth, leading up to and through retirement, and at their passing. Our team would be happy to further discuss given your financial situation and goals.
In conclusion, deciding which spouse should convert a traditional IRA to a Roth IRA depends on a variety of factors, including income tax implications, individual retirement savings, income limits, age, and overall financial situation. It’s important for couples to carefully consider these factors and consult with a financial advisor or tax professional before making a decision.
By taking the time to carefully evaluate their options, couples can help ensure that they make the best decision for their individual and joint financial goals.
For this question and any other, we offer a complimentary 15-minute call to discuss your financial situation and concerns and share how we may be able to help.
[1] Retirement Pension or Annuity Subtraction www.tax.colorado.gov/retirees
[2] Retirement Topics – IRA Contribution Limits www.irs.gov
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