There is no legal or regulatory age restriction on Roth conversions, so it's not too late in that sense. Generally speaking, a Roth conversion may make more sense for a younger saver. However, there are a number of other considerations that may be more important to keep in mind. For instance, unless you are likely to be in a higher tax bracket after retirement, or you plan to leave your retirement account to heirs as part of your estate plan, it may not be advantageous to do a Roth conversion. Tax costs and potential restrictions on when you'll be able to withdraw converted funds penalty free are among the factors to include in your analysis. Here are some things to think about.
If you're considering a Roth conversion, talk over the move with a financial advisor.
Key Principles of Roth Conversions
If you have saved for retirement using an IRA, 401(k) or similar tax-deferred account, once you reach a certain age, you'll have to start taking taxable Required Minimum Distributions (RMDs) from the account every year. Some retirement savers, concerned about the potential impact this could have on their post-retirement tax bill, look into a Roth conversion. This involves transferring funds from the tax-deferred account to a Roth IRA, which is not subject to RMD rules.
A Roth conversion frees you from having to take RMDs, but you'll have to pay taxes on converted funds now as if they were ordinary income. This can lead to a large current tax bill. If, as many people do, you are in a lower marginal income tax bracket after retirement, then a Roth conversion could cost you more in taxes than leaving the money in the IRA. So part of making the decision to convert is projecting your future income and tax bracket.
A Roth conversion can have some other advantages. Notably, withdrawals of converted funds are tax-free, so you won't owe any income taxes if you opt to take distributions after you've retired. Also, funds in a Roth account can be passed tax-free to heirs. So a Roth conversion can be a useful part of an estate plan.
But it also has some other limitations. One is that, due to the five-year rule, you may not be able to withdraw converted funds within five years without owing a penalty. For this reason, it's often wisest to only convert funds that you won't need for future living expenses. But at 60, you may be able to bypass the five-year rule on a Roth conversion, as the rules ease up beyond 59.5.
Breaking Down a Roth Conversion
If you are a single filer with $100,000 in taxable income, converting a $930,000 IRA could result in a sizable current tax bill. The entire converted amount would be treated as ordinary income. The resulting $1,030,000 in combined income would lift you to the 37% marginal bracket and result in a federal income tax bill of approximately $366,742, using the 2024 tax brackets and rates.
You can manage this tax bill by converting only a portion of the IRA balance each year. One approach is to convert only enough IRA funds to boost your taxable income to the top of your current bracket or the next-higher bracket. For instance, say you converted $91,949 of your IRA. Added to your other taxable income of $100,000, a tax calculator shows this would result in taxable income of $191,949, just below the top of the next-highest bracket of 24%. This would mean a current tax bill of $48,842.
You could perform this gradual conversion process annually for 15 years, until you reach age 75 and are subject to RMDs. By then you would have converted 15 times $91,949 or $1,379,235. Assuming tax brackets and rates don't change, you would pay total taxes of 15 times $35,606 or $534,090. While this is more than the $366,742 owed in taxes on a one-time full conversion, it would be spread out over 15 years, which could help manage your tax bill.
Remember, this example is simplified for illustrative purposes. A financial advisor can help you determine an optimal tax and conversion strategy. Use this free tool to match with a financial advisor.
Maximizing Your Roth Conversion Strategy
There are a number of other factors to keep in mind when considering a Roth conversion strategy. One is that it's generally best to pay any current tax bill due with other funds. That is, try to avoid using converted funds to pay the taxes on the conversion. This allows the money to stay in the tax-advantaged account and grow tax-free.
Also consider that converting $91,949 annually for 15 years might not completely empty the IRA. Assuming an annual investment return averaging 7%, an investment calculator indicates that at the end of this process you would still have approximately $220,797 in your IRA. This amount would still be subject to RMDs. However, the mandatory withdrawal would be much smaller, and it could be advantageous to leave some money in your IRA depending on your circumstances.
Also bear in mind that the conversion income could affect taxes on Social Security benefits. Medicare premiums and your eligibility for certain tax credits like the Premium Tax Credit could also be affected.
The major question is whether your tax bracket and rate will be lower or higher in retirement. If you expect to be in a higher bracket after retirement, a Roth conversion or series of Roth conversions may make sense. If you expect to be in a lower bracket, you might save money by leaving the funds in your IRA, taking RMDs and paying taxes on them at your lower post-retirement rate.
Finally, bear in mind that a Roth conversion cannot be undone. Once you have converted funds, you can't move them back. So you'll want to make sure this is your best move before proceeding. Consider speaking your plan over with a financial advisor to review your options and tradeoffs.
Bottom Line
You can do a Roth conversion at any age and with any amount, but that doesn't mean it always makes sense. For instance, if you expect to be in a lower tax bracket after retirement, you may be better off leaving money in a tax-deferred account and paying income taxes on the RMDs as needed. If you do decide to do the conversion, you may want to consider gradually converting the IRA over a number of years. This can spread out your tax payments and make it easier to manage. It's also likely to make more sense to convert if you have other sources of funds to pay the taxes due on the conversion. Using converted funds to pay the taxes means reducing the balance you'll have available for tax-free growth.
Tips
- Finding a financial advisor doesn't have to be hard. SmartAsset's free tool matches you with vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you're ready to find an advisor who can help you achieve your financial goals, get started now.
- Find the highest available return on the cash portion of your portfolio with SmartAsset's Best Money Market Accounts comparison tool.
- Keep an emergency fund on hand in case you run into unexpected expenses. An emergency fund should be liquid — in an account that isn’t at risk of significant fluctuation like the stock market. The tradeoff is that the value of liquid cash can be eroded by inflation. But a high-interest account allows you to earn compound interest. Compare savings accounts from these banks.
- Are you a financial advisor looking to grow your business? SmartAsset AMP helps advisors connect with leads and offers marketing automation solutions so you can spend more time making conversions. Learn more about SmartAsset AMP.
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The post I’m 60 With $930k in My IRA and Have Started Social Security. Is It Too Late for a Roth Conversion? appeared first on SmartReads by SmartAsset.
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