With investment accounts about to have a very good year and current tax rates unlikely to change for a while, paying taxes now to convert traditional IRAs and 401(k)s into Roth accounts is tricky.
Yet one financial advisory platform, Boldin, saw a 128% increase in usage of its Roth conversion calculator in 2024 over the previous year.
Formerly known as NewRetirement, Boldin hears from a variety of users who have saved well in tax-deferred accounts throughout their careers and now, as they approach retirement, see the looming required minimum distributions as a problem.
“It’s starting to dawn on them,” said Steve Chen, CEO of Boldin. “Most of our users are 401(k) millionaires over 50, and they’re starting to realize that it’s not just about returns, it’s also about where your money is.”
Required minimum distributions are the IRS version of deferred gratification. You can set aside money each year that grows tax-free in qualified accounts while you work, but at some point you’ll have to pay taxes on that money. Currently that point is at the age of 73, but in 2033 this will shift to 75 years. There is a formula that the government applies based on your age and account balance to determine how much you should withdraw.
The problem for 401(k) millionaires in their 50s (or younger) is that in the 20 years before they need to start withdrawing money, they can accumulate $4 million at compound growth, even at a modest growth rate. That would mean an RMD of at least $150,000, which counts as taxable income. With Social Security and other taxable investment gains — along with wages, for those still working at age 73 — that will push them into higher tax brackets than they might have assumed. Additionally, they will likely eventually have to pay IRMAA surcharges on Medicare premiums.
If you’re likely to withdraw more from your qualified retirement accounts each year than is necessary for living expenses, then you generally won’t be mad about your RMDs, and Roth conversions aren’t for you. If you’re worried that your savings won’t last your lifetime, it’s not worth thinking about whether you have to pay taxes now or pay taxes later.
Concerns about RMDs are generally reserved for people with large balances in tax-deferred accounts that will more than cover their needs. The idea is that you systematically withdraw large amounts of money from your accounts, convert that money into a Roth account, and pay the tax owed with other savings so that you don’t reduce the amount you’ve set aside for future tax-free growth by paying the tax with the recording itself. What counts as large amounts can range from $25,000 to $200,000 per year over several years, says Nicholas Yeomans, a certified financial planner based in Georgia.
It’s optimal to make this type of conversion if you’re in the 24% tax bracket or lower and you think your rate will increase in the future because you anticipate that your income or tax laws may change. It’s also better to do this when the financial markets are down so you can pay less in taxes and catch the uptick in growth in the Roth, where it will happen tax-free and where there are no looming RMDs for you or your partner. heirs to worry about.
However, that is not the situation at the moment. The stock market has risen sharply this year and the new Trump administration, with the help of Republicans in the House of Representatives and the Senate, will likely cut tax rates or raise current rates.
“I don’t think people had that on their bingo cards 45 days ago,” says Stash Graham, a wealth manager based in Washington, DC.
But that doesn’t mean Roth conversion activity has stopped. Conversely, the situation has given rise to an alternative argument for making it happen. For starters, your RMD amount will be locked into your account balance starting December 31, and many people will see higher RMDs next year because of this year’s gains.
Graham also noted that whatever happens on the tax front in the coming years won’t last forever — and may not even last longer than a typical multi-year Roth conversion strategy, which might last as long as a decade. What happens in the next two years may be overtaken by changes in seven or eight years.
“We are still advising customers, especially younger customers, that if their future earning potential is higher, then we should go ahead and complete your conversion now,” Graham said. “If you want to do this conversion, it’s probably cheaper to do it now, rather than later.”
Graham said he just had a conversation with a recently retired wealthy client in his mid-60s who was thinking about his upcoming RMDs. The best time to start these types of conversions is usually before age 63, when additional income can lead to Medicare IRMAA surcharges.
The customer may have been a little late, but he wasn’t thinking about himself. He planned to leave that money to his children, and he wanted to rip off the Band-Aid and do a major renovation so they wouldn’t be saddled with an inheritance that they would have to pay taxes on at their high rates in ten years. . His thinking was this: he used to be in the low 30% tax bracket, and now he’s in a much lower tax bracket – certainly lower than what his children would pay. “It’s a one-off and he feels like he can absorb it,” Graham said.
Graham’s job was to take this plan, run calculations on it, and compare it to the alternatives, such as stretching the conversions out over five years or more, or giving away some of the money.
Another multi-layered strategy is one that Yeomans used with a client who used the tax savings from a large charitable donation to cover the tax burden of a Roth conversion. Typically, this works best with a qualified charitable donation from an IRA, which allows you to give away up to $105,000, satisfying an RMD and reducing next year’s RMD (this amount will increase to $108,000 in 2025, as QCDs are now indexed for inflation). You must be at least 70½ for this.
However, many clients have large stock positions in investment accounts, perhaps because of business options or an inheritance. As they grow, cashing them out creates a tax burden, so one solution is to donate those shares directly to charity or put them in a donor-advised fund to distribute later. If you accumulate several years’ worth of intended donations, you can probably itemize your Schedule A expenses instead of taking the standard deduction.
“We identify how much tax savings the donation would generate, and then we go back to what kind of Roth conversion would wash away those tax savings,” Yeomans said. The effect is that the client can do a Roth conversion, be generous, not generate any capital gains, and ultimately not have to pay any additional taxes. “We are also bringing down future RMDs,” Yeomans added. “It’s a great strategy that’s being overlooked.”
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