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If you’re nearing retirement and have a sizable IRA balance, you’ll face some important decisions about required withdrawals and taxes. Converting a traditional IRA to a Roth account is a step that can increase your planning flexibility. And even at age 64, moving an account from tax-deferred to tax-exempt status can result in greater control over income distribution, as well as potential estate planning benefits.
A financial advisor can help you decide if Roth conversions are right for you. Talk to a fiduciary financial advisor today.
When you make a Roth conversion, you transfer money from a traditional traditional IRA to a Roth IRA. There are no age restrictions for performing Roth conversions, but the assets must remain in the Roth IRA for at least five years after the conversion or you may be subject to a 10% early withdrawal penalty. On the other hand, this five-year rule for Roth conversions does not apply to people who have reached age 59.5.
Roth conversions can be attractive 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 increasing taxable income and pushing them into a higher marginal income tax bracket.
However, the immediate tax bill that must be paid is the biggest challenge when performing a Roth conversion. If you make such a conversion, the previously deferred funds in your IRA will be treated as taxable income in the year the conversion occurs. A 64-year-old couple converting $750,000 from a traditional IRA to a Roth would incur a significant tax liability. If the $750,000 is treated as ordinary income, which it likely would be, it could push you into the top federal bracket of 37% and result in a six-figure tax bill.
Keep in mind that a financial advisor can help you estimate how much tax you might owe on a Roth conversion and possibly develop an alternative strategy.
The all-in-one conversion method is not the only approach. It is also possible to spread the conversion 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 a $750,000 conversion could go.
If you convert the entire $750,000 IRA balance to a Roth IRA in tax year 2024, the entire amount will likely be treated as ordinary income, on which taxes will be due on your next return. After subtracting the $29,200 standard deduction available to married couples filing jointly, $720,800 of this amount would be taxable. This would push you and your spouse into the top marginal tax bracket of 37% and leave you with a tax bill of about $193,000.
Alternatively, by converting $75,000 per year for 10 years, you will only owe income tax on the $75,000 converted each year. With that income, $37,862 of your Social Security benefits would be subject to income taxes, giving you a taxable income of $83,662.
Assuming tax brackets remain similar to those for 2024, you would only owe about $9,575 in annual federal income taxes for each $75,000 conversion. Over the full 10 years you will pay approximately €96,000 in income tax, saving approximately €100,000 compared to the all-in-one conversion option.
A financial advisor can help you perform these types of calculations and then make decisions based on those projections.
When deciding whether to convert a traditional IRA to a Roth, you need to look at more than just federal income taxes on the converted amount. Other concerns include state income taxes, taxes on Social Security benefits, and potential estate planning implications.
One thing you want to do is compare current tax rates to what they could be in the future. The current tax brackets, established in 2018 under the Tax Cuts and Jobs Act, will return to pre-2018 levels in 2025 (adjusted for inflation). saves you money, despite the upfront taxes due on the conversion. However, you may want to discuss these types of tax planning questions with a financial advisor.
Estate planning considerations are also critical. Roth IRA assets can be passed on to heirs tax-free, but if you plan to leave a gift to charity, it may make more sense to keep the money in traditional tax-deferred vehicles.
The income realized from Roth conversions can also affect your Medicare premiums and tax credits, so consider these effects as well. Plus, you’ll need access to non-retirement money to pay conversion taxes. Otherwise, you may have to liquidate investments at potentially inopportune times. A financial advisor can make projections and help you determine when to make a Roth conversion and how much.
Roth IRA conversions allow investors to gain more control over how their money is ultimately taxed, while also unlocking tax-free income in retirement. Partial conversions over several years can lead to a lighter tax liability. However, comparing current and future tax rates, analyzing total costs, weighing estate planning considerations, and modeling different Roth conversion approaches tailored to your specific financial situation are all important parts of this process.
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A Roth conversion decision requires an in-depth evaluation from all angles. Consider hiring a financial advisor to help you assess whether and how to make a large IRA conversion. 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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Before you make any important decisions about what to do with your retirement money, you want to know how much you are likely to have saved as your retirement date approaches. SmartAsset’s retirement calculator can help you predict how much you could have and whether you’re on track to meet your recommended savings goal.
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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 We are 64 years old with $750,000 in an IRA and Social Security. Is it too late to convert to a Roth IRA? first appeared on SmartReads by SmartAsset.
