At age 55 with $900,000 in a traditional individual retirement account (IRA), converting $100,000 per year to a Roth IRA could help reduce required minimum distributions (RMDs) and related taxes in retirement. Although Roth conversions create current tax liabilities, paying taxes now may result in more predictable and lower lifetime taxes.

Taking an incremental Roth conversion approach can effectively distribute the tax impact over time and keep you in lower tax brackets depending on your total income in any given year rather than making the conversion all at once. Moving your nest egg to a Roth IRA will not only help you avoid RMDs, it’ll also also protect your withdrawals from income taxes down the road, despite the initial tax hit on the conversion.

For personalized guidance on Roth IRA conversions and other retirement planning decisions, consider working with a financial advisor who can review your full financial picture.

RMD Basics

As a retirement saver using a traditional IRA, you are free to leave your retirement savings in the account to grow tax-free, but only up to a point. Once IRA holders reach age 73, they must start taking annual RMDs. The amount of each RMD is based on IRS life expectancy tables and account balances. This is a matter of concern because each RMD withdrawal adds to taxable income for that year. With large IRAs, annual RMDs can easily push retirees into higher income tax brackets, resulting in bigger tax bills down the road.

Avoiding RMDs with Roth Conversions

Since a Roth IRA isn’t subject to RMD rules, converting a traditional IRA to a Roth account can allow a saver to avoid some future mandatory withdrawals. The catch is, when you convert IRA funds into Roth funds you trigger ordinary income taxes immediately. One way to manage this is to take an incremental conversion approach, distributing the tax impact over time and potentially reducing the total tax burden.

Note that if you do choose to pursue a Roth conversion, you won’t be able to make withdrawals within five years of opening the account. This rule applies regardless of your age. A financial advisor can help you navigate the intricacies of a Roth conversion.

RMD Impact in Action

Starting with a $900,000 IRA at age 55, assuming a 5% annual growth rate and no contributions or withdrawals, your IRA would be worth approximately $2,165,957 when you turn 73 in 18 years. Dividing $2,165,957 by the IRS life expectancy factor of 26.5 for a 73-year-old gives you $81,734. This would be your first-year RMD.

Adding that $81,734 distribution to other retirement income sources increases the tax rate that applies to the RMDs.

For example, assume at age 73 your income from investments or similar taxable sources is $24,000 per year. Using 2024 tax brackets, if you’re single, that would put you just over the 22% tax bracket.

Now add $81,734 from RMDs. Your taxable income becomes $105,734, bumping you into the 24% tax bracket, and a much higher tax bill. Talk to a financial advisor about the ways to mitigate your taxes in retirement.

The Effect of Partial Conversion

You could avoid having to take these RMDs by converting your IRA to a Roth. However, Converting the entire $900,000 now would produce a six-figure tax bill due next time you file your return. Alternatively, a gradual conversion of $100,000 per year could reduce that tax hit and spread it out over time.

An important feature of this strategy is you can adjust it to keep your total taxable income just below the threshold for the next tax bracket. That’s the right idea.

If you stick with the $100,000 annual conversion, you move your entire IRA into Roth IRA account not subject to RMDs over a period of about 12 years, assuming the remaining funds in your IRA grow at 5%. Meanwhile, you may be able to keep your current taxable income in a lower tax bracket than if you did larger conversions.

Things to Consider Before Converting

Roth conversions carry risks and limits. One challenge is that you’ll need sufficient non-retirement funds to pay conversion taxes now. Also, future tax rates and laws frequently change. Tax rates could decline in the future. Fluctuating investment returns and personal factors like deductions and state taxes also can affect the result of a Roth conversion plan such as this.

An important consideration is that converted Roth funds typically can’t be withdrawn tax-free for five years after transfer. Earnings withdrawn sooner may incur taxes and penalties. This means Roth conversion planning requires predicting cash flow needs several years out.

Discuss how various tax strategies might impact your portfolio with a financial advisor.

Bottom Line

Strategic partial Roth IRA conversions enable investors to take control over their tax liability timing. Paying taxes now through gradual conversions may reduce overall lifetime taxes compared to unpredictable mandatory RMD withdrawals decades later. But Roth transfers also create present tax bills and limit tax-free access to converted assets for five years. Determining suitable Roth conversion amounts and timing given uncertain future tax rates and laws requires assessing several factors about the present and making reasonable assumptions about the future.

Tips

  • If you have questions about Roth IRA conversions or want help developing a retirement distribution strategy tailored for your situation, consider connecting with a financial advisor. 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.
  • To estimate out how much your nest egg will be worth years or decades from now, use SmartAsset’s Investment Return and Growth Calculator.

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