Converting an IRA to a Roth IRA is a popular approach to avoiding required minimum distributions (RMDs) – and the associated taxes – in your 70s and beyond. Doing this gradually can extend and even reduce your tax bill compared to converting it all at once. In your case, the most important question is probably whether $90,000 is the right amount to convert each year. Assuming some portfolio growth occurs along the way, this exact conversion plan will reduce the size of annual mandatory withdrawals later, but you can’t avoid them completely. On the other hand, if you turn over a larger amount each year, your current tax bill will increase. A financial advisor can help you model different scenarios so you can decide which approach makes the most sense for your situation.
Assuming your tax filing status is single and the $125,000 is taxable income after deductions and credits, you will be in the 24% marginal income tax bracket for the 2023 tax year. Your federal income tax bill is approximately $20,076. If you now turn over €90,000, your income will increase to €215,000 and you will end up in the 32% bracket. Your income tax bill for one year will increase $23,124 to $43,200. Over a ten-year period, your additional taxes owed from Roth conversions, which increase your taxable income, would come to about $230,000, not taking into account potential portfolio growth and inflation.
Alternatively, you can convert the entire $900.00 at once. That would put you in the top 37% bracket and increase your current annual income to $1,025,000. Your tax bill would skyrocket to $366,678, an increase of about $130,000 over the staggered approach. Please note that these are simplified calculations. A financial advisor can help you make more advanced projections in different scenarios.
Considering the tax savings compared to a one-year conversion, a gradual conversion seems like a promising strategy. However, making a lump sum payment each year may not be the most effective approach. For example, if you convert 10% of your IRA each year, you won’t completely deplete your IRA after 10 years. That’s because the remaining balance is likely to rise as a result of investment returns over that period.
If you convert $90,000 annually while earning an average return of 7%, you will still have about $500,000 left in your IRA after 10 years. If you use the IRS tables to calculate RMDs, your required annual withdrawal amount in the first year will be just under $20,000. This relatively small amount should not cause your income to increase so much that you end up in the next tax bracket. However, if you want to avoid RMDs completely, you will likely need to convert larger amounts.
In your case, assuming a starting balance of $900,000 and a 7% return for 10 years, you would need to convert about $128,000 per year for 10 years to have a zero balance in your IRA when you turn 73 and start taking RMDs. Added to your current income of $125,000, a conversion of $121,000 would give you $253,000 in income and put you in the second highest bracket at 35%, resulting in an annual federal income tax liability of approximately $70,000.
It may make more sense to convert only enough IRA funds to bring your income to the top of your current bracket. For 2024, the highest income in your current 24% bracket is $191,950. If you stay under that amount, you can convert $66,950 each year without making the big jump to the 32% bracket.
Simplified examples like this don’t take into account a number of factors that may be important. Additional income, changes in tax rates or tax brackets, income taxes, your projected retirement age, your expected lifespan, and future inflation and investment returns are all elements to consider when making plans for a long-term project such as converting your IRA to a Roth IRA .
You may plan to never take the Roth IRA money. This can be part of an estate plan. If you plan to withdraw funds during your retirement and you are under age 59.5, it is important to remember that the conversion separately has a five-year waiting period before you can withdraw from your Roth IRA without having to owe taxes and fines. However, this five-year rule does not apply if you are older than 59.5 years and is therefore not relevant to your case.
Remember that a financial advisor can provide personalized advice for your retirement goals.
Gradually converting your IRA to a Roth IRA may make sense if you want to avoid RMDs later while managing your current tax bill. However, you may need to convert more than 10% of your $900,000 IRA each year if you want to avoid RMDs as much as possible. The most useful conversion amount is likely the amount that increases your current taxable income to the top of your current marginal income tax bracket.
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A financial advisor can help you assess the factors that determine how to approach Roth conversion in your specific situations. Finding a financial advisor does not have to be difficult. SmartAsset’s free tool matches you with up to three financial advisors in your area, and you can interview your advisors for free to decide which one 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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Use SmartAsset’s federal income tax calculator to help you model the tax effects of different Roth conversion methods.
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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 isn’t 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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The post I’m 63 and make $125,000, with $900,000 in an IRA. Should I do a Roth conversion for $90,000 per year to avoid RMDs? first appeared on SmartReads by SmartAsset.
