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If you’re nearing retirement and you have a sizeable IRA balance, you face some significant decisions surrounding required withdrawals and taxes. Converting a traditional IRA into a Roth account is one move that can increase your planning flexibility. And even at 64 years old, shifting an account from a tax-deferred to tax-free status can result in greater control over income distributions, as well as potential estate planning benefits.
A financial advisor can help decide if Roth conversions are right for you. Speak with a fiduciary financial advisor today.
When you do a Roth conversion, you transfer funds from a traditional traditional IRA into a Roth IRA. There are no age restrictions on doing Roth conversions, but the assets must remain in the Roth IRA for at least five years after the conversion or they could be subject to a 10% early withdrawal penalty. Then again, this five-year rule on Roth conversions does not apply to people who have reached age 59 ½.
Roth conversions can be appealing because withdrawals from Roth accounts can be made tax-free, as long as the account was opened five years before the withdrawal. Roth accounts are also not subject to required minimum distributions (RMDs). That means retirees don’t have to worry about RMDs adding taxable income and pushing them into a higher marginal income tax bracket.
However, the immediate tax bill that comes due is the biggest challenge of doing a Roth conversion. If you do such a conversion, the funds in your IRA that were previously tax deferred are treated as taxable income in the year the conversion happens. A 64-year-old couple converting $750,000 from a traditional IRA to a Roth would generate a substantial tax obligation. If the $750,000 is treated as ordinary income, as it likely would be, it could push you into the highest 37% federal bracket and result in a six-figure tax bill.
Keep in mind that a financial advisor can help you project how much you could owe in taxes on a Roth conversion and potentially develop an alternative strategy.
The all-at-once conversion method is not the only approach. It’s also possible to spread the conversion out over several years, potentially reducing the tax impact. If you and your spouse are both retired and receive $44,544 in combined annual Social Security benefits (the average retirement benefit in December 2023 was $1,856 per month) there are several ways that a $750,000 conversion could play out.
