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If you’re retired, it’s not too late to convert your money into a Roth IRA. The IRS lets you convert qualified funds at any time, as long as you pay the associated taxes.
However, it may be too late to really benefit from that decision. A Roth IRA works best when it has time to grow and when you can take advantage of tax arbitrage between current (lower) rates and future (higher) rates.
For example, suppose you are 70 years old and have $1.2 million in your IRA. Legally, it’s not too late to convert that money into an after-tax account. In practice, however, you would pay about $400,000 in conversion taxes in exchange for avoiding required minimum distributions (RMDs) and tax-free growth for the future.
But there’s more to think about. If you would like to ask questions about your own personal situation, consider matching with a fiduciary financial advisor.
Investors who hold money in a pre-tax portfolio, such as a traditional IRA or a 401(k), can do what’s called a Roth conversion. This is when you move assets out of your pre-tax portfolio and put them into a Roth IRA. A Roth conversion has no limits, unlike contributions from earned income. You can convert assets in any amount and as often as you like. Otherwise, at age 70, you must still have qualifying income from work or a business to make regular contributions, which are limited by an annual limit.
The main after-tax benefit of a Roth IRA is withdrawals. You pay no taxes on any withdrawals from a Roth IRA, either principal or returns. This is in contrast to a pre-tax portfolio, where you pay no tax on the money you bring in, but full income tax on the money you withdraw. A Roth IRA also has no RMD requirements, allowing you to hold investments for as long as you want.
This tax status makes a Roth IRA good for estate planning because your heirs can also withdraw the money tax-free. This is unlike a pre-tax account, such as a traditional IRA, on which your heirs would pay income taxes.
Consider discussing with a financial advisor how a Roth conversion would impact your retirement and estate planning goals.
The biggest drawback to a Roth IRA is its contributory tax status. You pay full income tax on the money you deposit into this account, either through contributions or conversions. For example, let’s say you convert $1.2 million from your traditional IRA to a Roth IRA. You would include that $1.2 million in your taxable income for the year, and you would need cash to pay the resulting taxes. If you convert this amount, you will probably end up in the highest tax bracket of 35%.
You can manage these taxes by converting money into smaller, spread amounts to stay within lower tax brackets, but you can’t avoid them entirely.
It’s also important to consider how and when to withdraw this money during your retirement. Any money you convert into a Roth IRA must also stay in place for at least five years. For example, if you convert money into a Roth IRA at age 70, you are not allowed to withdraw it before age 75 without penalty.
A financial advisor can help you plan for blended fund accounts, where some of the money is accessible but some remains blocked.
It’s easy to think that a Roth IRA is automatically the better choice. After all, the Roth portfolio enjoys tax-free growth and withdrawals. So if you put in $1 and it grows to $10, with a Roth IRA you only pay taxes on the $1. With a traditional IRA, you pay taxes on all $10.
The problem is that the tax you pay on premiums and conversions is all the money you could have invested. For example, let’s say you roll $1.2 million from your traditional IRA to your Roth IRA. If done all at once, it would cost about $399,000 in taxes. If you invest at an 8% growth rate, at age 75 that’s the difference between $1.76 million in savings and $1.17 million.
So the rule of thumb is this:
A Roth investment is a good idea if you currently pay lower taxes than you expect to pay upon withdrawal, so you are trading the current lower rate for the higher future rate (tax arbitrage). It’s also a better idea the longer your money should grow tax-free in this account.
A pre-tax investment is a good idea if you are currently paying higher taxes than you expect to pay upon withdrawal, so you are trading your current higher rate for a future lower rate (capital maximization).
A financial advisor can help you with a personal evaluation of the pros and cons in your situation.
Suppose you are retired. You’ll be sitting on $1.2 million in a traditional IRA at age 70. Is it too late to convert your savings to a Roth IRA?
Well yes and no.
No, it is not legally too late. The IRS allows you to make a conversion at any time, as long as you have qualifying funds, such as a traditional IRA, and can pay the conversion taxes. At age 70, you can withdraw that money from your IRA. This gives you the money to pay your conversion taxes, but reduces your portfolio by the amount of the tax bill.
However, chances are it’s too late for you to get real value from this account. At age 70, you have probably determined your retirement income. It is unlikely that you will pay a significantly different tax rate in later years than you do now. Ideally, your portfolio still has plenty of time to grow, but the tax-free growth is unlikely to compensate for the lost capital.
Take our example above. If you convert this money all at once, you could have about $1.17 million in your Roth portfolio at age 75. At a 4% withdrawal rate, that’s about $46,800 in after-tax income. If you don’t convert this money, you could end up with about $1.76 million in traditional IRA. At a 4% withdrawal rate, that’s approximately $62,651 in after-tax income (excluding state and local taxes).
This is a clumsy example. You would most likely convert this money in stages to avoid the highest tax brackets, increasing the value of your Roth portfolio. But the thing is, you don’t have much of an advantage here. Unless you expect your income to drop significantly later in retirement, you won’t have any future tax benefits to offset the current bill you would pay.
Not to mention locking in your retirement portfolio for five years… right when you need it most.
A Roth conversion may make sense if this is a supplemental retirement account. Then a few edge cases can make this useful for money management. For example, if you convert your money to a Roth portfolio, you can make large, one-time withdrawals (such as for a new car or a big trip) without incurring higher taxes this year. It can also be useful in estate planning, if you want to leave your heirs a valuable, tax-free asset. But these cases are relatively niche and still cannot compensate for the value lost in taxes.
When it comes to income and personal savings, chances are that a Roth conversion at age 70 won’t save you much money, and it may even do more harm than good.
If you have questions about your retirement income and taxes, contact a financial advisor today.
At age 70, it’s not too late to legally build a Roth IRA. However, converting your savings mid-retirement is a risky move, and it could cost you much more in the long run than you save on taxes.
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Now let’s look at this from another point of view. Let’s say you already have a Roth IRA and you’re finishing up work. What Should You Do With Your Roth IRA When You Retire?
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A financial advisor can help you draw up a comprehensive retirement plan. 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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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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