At 67, you’re presumably at or near retirement. If you have $1 million in IRAs, it may be attractive to converting to a Roth because it can provide tax-free income in retirement.
It’s not too late from legal or regulatory perspectives. The IRS does not restrict Roth conversions on the basis of age or income. You won’t be able to make a proper withdrawal from a Roth for five years after you open it, but if you have existing traditional IRA assets, you can convert them. However, when making this decision at a later stage of life, noteworthy financial tradeoffs around taxes, healthcare costs, estate planning and more come into play. Ask a financial advisor if Roth IRA conversion makes sense for you.
Understanding Roth IRA Conversions
A Roth conversion involves moving retirement savings from a traditional IRA account into a Roth IRA account. Traditional IRA contributions provide tax deductions, lowering your taxable income each year you contribute. But traditional IRA withdrawals taken during retirement get taxed as ordinary income based on whatever tax bracket you fall into at that time.
Roth IRAs work in the opposite manner. Contributions are made using after-tax dollars, so you don’t lower your current taxable income with contributions. However, qualified withdrawals later in retirement are completely tax-free. The conversion catch is that when you do one you have to pay any taxes due now on the funds you convert. This is not an insignificant concern.
A 67-year-old couple converting their entire $1 million traditional IRA into a Roth version in a single year would owe income tax immediately on the entire converted balance. This lump of income would also put them into the highest income tax bracket. Tax rates could be as high as 37% federally, plus applicable state taxes of 5% to 13% depending on your location. Naturally, few people are eager to write a six-figure check to the IRS, although there are ways to make this less painful.
Talk to a financial advisor to discuss your options for rollovers and retirement planning.
Roth IRA Conversion Specifics
Let’s walk through what could happen if a retired 67-year old couple with $1 million in a traditional IRA and average combined annual Social Security benefits of about $44,000 decides to convert to a Roth IRA. There are two main ways of doing this, including all at once and over time.
If they opted to convert the entire $1 million IRA balance to a Roth IRA in a single tax year, they would incur federal and state income taxes that year on the full $1 million converted amount, placing them in the highest income tax bracket. Total ordinary tax rates could approach 40% to 45%, or $400,000 to $450,000 on a $1-million conversion.
That’s the all-at-once approach. By taking their time and spreading the $1 million conversion over 10 years at $100,000 converted per year, they would only owe income tax each year on $100,000. Assuming for this example that Social Security benefits and income tax brackets stay unchanged, they would be in the 22% federal tax bracket. They would owe $22,000 federal tax on each $100,000 conversion, a much more manageable bill. Plus, total tax over 10 years comes to $220,000 or about half as much as the all-at-once approach.
However, note that this strategy is only worthwhile if they don’t need the money until late in retirement, as they’ll need to let the account age at least five years before making a proper withdrawal. This may be useful if they’re looking to leave a tax-free inheritance.
They would still owe taxes on their Social Security benefits as well in each of those 10 years. But diverting some savings into the Roth IRA provides some future tax-free income capacity that can be drawn on to balance out taxes owed later on traditional 401(k) or IRA withdrawals. Conversion diversification lets them prudently minimize their overall lifetime tax liability. It also creates a pool of tax-free legacy money if they eventually gift a portion of the Roth account to children or grandchildren.
You can review your options for minimizing taxes and maximizing retirement income with a financial advisor.
Additional Roth IRA Conversion Considerations
Other factors also may weigh on a sizable Roth IRA conversion decision. For instance, realizing the conversion income could impact taxation of Social Security benefits, Medicare premiums and eligibility for certain tax credits like the Premium Tax Credit. Any Required Minimum Distributions (RMDs) already taking place on the existing traditional IRA would need to be accounted for in multi-year projections also.
Estate plans should also be taken into account. For instance, if you plan to leave all your wealth to a charity, it likely makes sense to leave funds in the traditional IRA rather than converting to a Roth because the charity won’t owe taxes on the bequest. You’ll also need to ensure beneficiaries on the Roth are named correctly and evaluate the conversion’s impact on any trusts you have set up.
Talk to a financial advisor about estate planning today.
Making the Roth IRA Conversion Call
If you’re thinking about doing a large Roth conversion, consider this process:
First, clarify what should happen to the IRA assets upon death – if the goal is leaving an inheritance to heirs entirely tax-free, then doing calculated Roth conversions can guarantee that continued tax-free growth.
Next, assess current marginal and future effective tax rates in retirement. If rates seem likely to rise substantially due to tax code changes, paying taxes now through a conversion could save money later.
Finally, analyze existing income streams, multi-year tax scenarios, healthcare budget and estate plans.
In most cases, you’ll wind up choosing not to convert all at once. For those with large traditional IRAs, strategic partial conversions tailored to your needs often makes the most financial sense. A financial advisor can help you weigh your options.
In summary, once you reach 67 years old and beyond, you still can convert all or part of your traditional IRA assets over to a Roth IRA. That doesn’t mean you should, however. To decide if this aligns with your, assess your multi-year tax picture, compare current and future tax brackets, understand total costs and implications involved, and pick a Roth conversion approach that works your particular financial situation. Converting everything in one year often won’t make as much sense as spreading conversions over time.
- A financial advisor can explain how a Roth IRA conversion would impact tax bills, estate planning, healthcare costs and more. SmartAsset’s free tool matches you with up to three financial advisors in your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
- Plug your figures into SmartAsset’s Social Security calculator to get a feel for how much your benefits will be after you retire.
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