Can a 10% Roth Conversion Plan Help You Minimize Taxes and Skip RMDs?

Roth IRA are not subject to rules on required minimum distributions (RMDs)and qualified withdrawals from Roth accounts during retirement are also free of federal income taxes. You can get these benefits for funds in your Traditional IRA by transferring them to a Roth account. You will now have to pay income tax on the funds you convert, but spreading the conversions over several years can help you manage and potentially reduce your overall tax liability. Still, there’s no way to completely avoid taxes, and conversion isn’t always the best strategy. Also, converting a set percentage each year isn’t the only way to do it.

A financial advisor can help you figure out if and how to do a Roth conversion. Pair up with a fiduciary advisor today.

If you save for retirement in a pre-tax account, such as a traditional IRA, you must start taking money out of the account after you turn 73 (or 75 in 2033 or later). These RMDs are taxable as ordinary income, which can cause problems for some retirees if they have to receive taxable income when they don’t need the funds to support their lifestyle.

For example, say you are 73 years old and receive $45,000 in taxable income Social Securitypensions and other sources. If you are a single filer, this would put you in the top 12% bracket using the 2024 income tax brackets and your federal tax bill would be approximately $3,500. If you also have to take $20,000 in RMDs, your new taxable income of $65,000 will put you in the 22% bracket and your federal tax bill will increase to approximately $6500.

if you convert your IRA to a Roth IRA before you turn 73, you won’t have to take any RMDs. Not only will this help you manage your taxes in retirement, but it will also allow your Roth funds to continue to grow tax-free. And you can also pass them on to your heirs tax-free, making the Roth conversion a useful estate planning tool.

However, these benefits come at a cost. If your traditional IRA has $500,000, for example, the tax bill to convert the full amount in a single year could be about $145,000, using Fiscal frames 2024 for a single file. Because of this, people doing Roth conversions sometimes stretch out the process over several years converting a part every year.

If you converted 10% of a $500,000 IRA annually, for example, it would increase your income in the first year by $50,000. Assuming your taxable income from other sources is $50,000, your taxable income will increase to $100,000. If you used the 2024 brackets for a single file, you’d be down to 22%. Over 10 years, you may have the opportunity to save money in tax compared to the lump sum conversion.

A financial advisor can help you calculate the tradeoffs for your own Roth conversion strategy and find an approach that’s right for your goals. Talk to a financial advisor today.

Despite the appeal, the Roth conversion has several drawbacks and limitations and is not for everyone. One of the main considerations is whether you will be in a lower tax bracket after retirement. If it is, you’re better off paying taxes than on your IRA withdrawals rather than paying taxes now to convert to a Roth.

Also, you cannot withdraw earnings from converted funds without owing a 10% penalty up to five years after making the conversion. This is known as the five year rule. Therefore, the conversion may not make financial sense if you are nearing retirement or may need the funds for another purpose, such as paying for a child’s college, in five years.

If the conversion seems to make sense, doing a certain percentage each year is just one approach. The idea is to convert just enough to bring your taxable income to the top of your current tax bracket. With that in mind, the dollar figure is more important than the percentage.

Also keep in mind that the decision whether or not to do a Roth conversion is based on a number of assumptions about the future, any of which may not turn out as expected. For example, you may choose not to convert because it looks like you’ll be in a lower tax bracket after retirement. However, the The 2017 tax cut will expire in 2026after which taxes may be higher. Generally, tax rates have been falling for decades and they are low compared to historical averages, suggesting they may go up before they go down.

consider partnership with a financial advisor to discuss your options for a Roth conversion.

Converting funds from your IRA to a Roth IRA can be a good move if you think you’ll be in a lower tax bracket after retirement. The conversion also gives you more control over withdrawals from your retirement account because Roth accounts are not subject to RMD rules. You’ll have to pay income taxes on any funds you roll over to a Roth, but gradually converting your IRA over a period of years can help reduce your overall tax burden.

Ask a financial advisor about how taxes may affect your retirement plan. The free SmartAsset tool connects you with up to three financial advisors in your area, and you can interview your advisors 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, start now.
Find out how much your RMDs will use SmartAsset Minimum Required Distribution Calculator.
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