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If you’re 65 years old and receiving Social Security, you may be wondering if it’s too late to convert your $750,000 traditional IRA to a Roth IRA. The short answer is no – there are no legal restrictions on Roth conversion based on age or income. In practice, however, the decision involves careful consideration of tax implications, healthcare costs, estate planning and more. Spreading conversions over several years often makes the most financial sense for larger IRAs. Guidance from a financial advisor can help you weigh the costs of a Roth conversion in your circumstances.
Basics of Roth Conversion
A Roth IRA conversion involves moving money from a pre-tax traditional IRA to an after-tax Roth IRA account. You pay income tax on the money converted now, but future withdrawals in retirement are tax-free.
Additionally, Traditional IRAs are subject to required minimum distributions (RMDs) beginning at age 73. This can lead to higher taxes in retirement, as RMD income, which is treated as ordinary taxable income, can push retirees into higher tax brackets. But the RMD rules don’t apply to Roth IRAs and Roth 401(k)s, so you can leave the money in the account or withdraw it when you need it without having to pay taxes on your contributions (you may owe income tax on your investments). income if you withdraw it within five years of your first contribution).
If you need additional help navigating the rules surrounding Roth IRAs, consider speaking to a financial advisor.
Why the timing of your Roth conversion is important
The sooner you convert money from your pre-tax traditional IRA to a Roth account, the more years of tax-free growth you will enjoy in your Roth account. And you can withdraw that Roth money without owing taxes.
But you’ll have to pay taxes on the conversion, which is no small consideration when it comes to timing. Converting a large IRA may require you to pay the top marginal tax rate of 37% on most or even all of the conversion amount, depending on your other income, deductions and additional factors.
However, if you convert it gradually, you can spread the income increase over several years and avoid subjecting it to the highest marginal tax rate. This can help reduce the annual and total tax liability.
It’s also important to consider when to withdraw money from your Roth IRA. The money cannot be withdrawn without penalty within five years of the conversion. And if you gradually convert your IRA to a Roth over time, those conversions each trigger the five-year rule for that portion of the money.
Meeting with a financial advisor can provide clarity on complex steps such as Roth conversions.
Converting a $750,000 IRA
A major problem with converting a $750,000 IRA balance at once would be the significant tax bill that would accompany such a transaction. A full Roth conversion of that size would push the person into the 37% marginal tax bracket.
If you are a single filer and your Social Security income is not high enough to be taxed, adding $750,000 to your current income could generate approximately $238,000 in additional taxes, using 2023 tax brackets. By going slowly With a turnover of $75,000 per year over a 10-year period, the tax burden is reduced each year by keeping your taxable income within the 22% bracket.
Here’s how these scenarios might play out, assuming you’re a single filer and your Social Security income is less than $25,000 so you escape tax:
Scenario 1: Convert €750,000 in one go
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Size of Roth Conversion: $750,000
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Tax bracket: 37%
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Total federal income tax owed: $237,831
This option will leave you with a huge tax bill, but about $512,000 to your new Roth IRA, which you can eventually withdraw tax-free.
Scenario 2: Annual conversions of €75,000 over ten years
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Size of Roth Conversion: $75,000 (x10)
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Tax bracket: 22%
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Total federal income tax owed: $88,000 over 10 years
Keep in mind that the money left in your IRA will continue to grow as you make these annual conversions, so the IRA likely won’t be empty by the time you need to start taking RMDs. However, the RMDs you need to take out by then will be much smaller, so you won’t be subject to as much tax compared to leaving the money in a traditional IRA.
A third option is to leave the money unconverted in your IRA and start taking RMDs once you turn 73, paying taxes on them along the way. However, this could leave you paying higher taxes until your death in retirement. But if you need more help sorting out your different options, this free matching tool can match you with a fiduciary advisor.
To call
You may not feel that one course of action is clearly superior. Factors to consider when deciding whether and how much Roth conversion makes sense:
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Compare current and future income tax rates
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Keep RMDs and estate plans in mind
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Weigh the costs for health care and other seniors
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Assess the tax consequences for heirs
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Model multi-year scenarios
Strategic partial Roth conversions tailored to your situation can provide the most tax benefits for people with large IRA balances.
A major limitation of Roth conversions is that they cannot be reversed. If tax rates drop later or you need converted money sooner, you may regret locking in taxes at a higher rate now. The inheritance plans can also change. Conduct a thorough multi-year analysis before deciding to convert.
Run your own Roth conversion scenarios first or enlist the help of a financial advisor to help you make these important calculations.
In short
At age 65 or any age, while parts of your retirement finances remain uncertain, limiting Roth conversions to small chunks spread over years offers flexibility. This offsets the immediate tax costs with future tax savings for you and your heirs. As with most money moves in retirement, it’s critical to carefully assess your multi-year tax picture first.
Retirement planning tips
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Instead of guessing whether converting your IRA makes sense, talk to a financial advisor who can crunch the numbers. Finding a financial advisor does not have to be difficult. SmartAsset’s free tool matches you with up to three vetted financial advisors serving your area, and you can have a free introductory meeting with your advisors to decide which one you think is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
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Please note that there are income restrictions on contributing to a Roth IRA. In 2024, the IRS will not allow single filers with an adjusted gross income (AGI) over $87,000, and married couples filing jointly with an AGI over $240,000. However, backdoor Roth IRAs can help high earners legally avoid these income limits.
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Have an emergency fund on hand in case you encounter unexpected expenses. An emergency fund should be liquid – in an account that is not at risk of significant fluctuations like the stock market. The trade-off is that the value of liquid cash can be eroded by inflation. But with a high-interest account, you can earn compound interest. Compare savings accounts from these banks.
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Are you a financial advisor looking to grow your business? SmartAsset AMP helps advisors connect with leads and provides marketing automation solutions so you can spend more time making conversions. Learn more about SmartAsset AMP.
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The post I am 65 years old with $750,000 in an IRA. I’m Taking Social Security – Is It Too Late for a Roth Conversion? first appeared on SmartReads by SmartAsset.
