Retiring Soon? 7 Things You Need To Know About Roth Conversions
Written by
Jordan Rosenfeld
Edited by
Molly Sullivan
Commitment to Our Readers
GOBankingRates' editorial team is committed to bringing you unbiased reviews and information. We use data-driven methodologies to evaluate financial products and services - our reviews and ratings are not influenced by advertisers. You can read more about our editorial guidelines and our products and services review methodology.
20 Years
Helping You Live Richer
Reviewed
by Experts
Trusted by
Millions of Readers
If retirement is in the near future for you, you are probably strategizing your savings and retirement accounts to be ready for drawing them down.
Some people opt to do a Roth conversion, moving funds from a pretax retirement account such as a 401(k) into a Roth IRA. This allows you to take your distributions tax-free (though you do pay taxes when you convert).
Experts explained what any soon-to-be retiree needs to know about a Roth conversion at this later stage of the game.
Take Advantage of a Lower Tax Rate
Even though it may not feel like it, the U.S. economy is still at historically low tax rates, according to Jordan Mangaliman, CEO of Goldline Financial Services. Considering a Roth conversion could enable retirees to allocate more money into their tax-free bucket.
If it seems like there’s little difference between paying taxes now or after you retire, Mangaliman said, “The main benefit of a Roth conversion is that you are choosing to pay taxes on the converted amount now while taxes are at a rate that you know.”
He asserted that many economists believe tax rates can and will go up due to the many things the government has to address, like reducing the deficit and funding essential services. Thus, by choosing to do a Roth conversion, “you are paying the taxes today and allowing the converted amount to grow tax-free and accessible tax-free after five years.”
Katherine Tierney, senior retirement strategist at Edward Jones, pointed out that doing a Roth conversion can also “[give] retirees more control over their tax bill in the future. Since taxes on Social Security benefits and Medicare premiums are also based on income level, it can help retirees save on these expenses as well.”
No RMDs but It Affects Other Taxes
Another benefit of a Roth IRA is that you don’t have to take required minimum distributions (RMDs) from a Roth account if you’re the original owner, allowing your assets the opportunity to grow tax-free over a longer period, Tierney said. However, if you’re doing a conversion at a late stage in the game, remember that the amount you convert is taxed in the year of conversion.
“This can also result in higher taxes on your Social Security benefits the year you convert and higher Medicare premium surcharges two years after conversion,” she said. Medicare premium surcharges are based on your income from two years ago.
Conversion Limits
There is no limit to how much you can convert from a pretax retirement account into a Roth IRA, Mangaliman said. However, as Tierney mentioned, the amount you decide to convert will be treated as taxable income so you want to keep your tax bracket in mind.
“It’s important to work with an experienced CPA or advisor that can help you plan out a schedule that allows you to convert without breaking into new tax brackets if it isn’t necessary,” he said.
Timing Is Crucial
Timing is also critical when considering if and when you should do a Roth conversion. It’s more ideal to convert during your low-income years because your conversion is treated as regular income, Mangaliman said.
However, he said, while “it’s never too late to do a Roth conversion … if you find yourself in your 80s still trying to do a Roth conversion, it’s important to remember that you must wait five years for the gain to be tax-free.”
You should consider doing a Roth conversion if you have enough retirement funds to live on and you have funds not needed for at least five years.
Consider Partial Conversions
A potential strategy to help reduce taxes is to do partial conversions over multiple tax years, Tierney said. “This way you can convert up to the amount available in your current tax bracket or before triggering additional Social Security taxes and Medicare surcharges.”
Withdrawals Must Be Qualified
To take tax-free distributions from a Roth account, you generally must be 59 ½ or older and have had the Roth account for at least five years, Tierney said. If you happen to be retiring before these criteria are met, a Roth conversion may not make sense for you.
Irreversible Transaction
Also, it’s important to remember that a Roth conversion is irreversible. Once you convert the funds, you can’t undo or reverse the transaction, Tierney explained. So it’s a decision you want to make with the help of your accountant or financial advisor.
Before you do a Roth conversion, be sure you consult with your financial professional.
More From GOBankingRates
