Key Points
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A Roth conversion could help you minimize RMDs and avoid other unwanted consequences.
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It’s important to time that conversion carefully for minimal tax repercussions.
If you spent many years saving for retirement, you may finally be gearing up to start enjoying your money. But if you don’t need everything you’ve saved, you may want to withdraw from your IRA or 401(k) minimally to keep your tax bill low and preserve more of a legacy for your loved ones.
Once required minimum distributions (RMDs) kick in, that becomes harder. Those forced withdrawals can not only whittle down your retirement account balance, but also leave you with higher taxes than you want to pay.
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And that’s not all. When your taxable income gets too high in retirement, other consequences could ensue. You could end up being taxed on your Social Security benefits and hit with Medicare surcharges.
That’s why it often pays to do a Roth conversion when you’ve saved a lot of money in a traditional retirement account. But if you’re going to use this strategy, there’s a key window to keep in mind.
It pays to do a Roth conversion the easy way
With a Roth conversion, you move funds from a traditional retirement account into a Roth IRA. Once that money lands in a Roth IRA, it gets to grow tax-free and isn’t subject to taxes on withdrawals. Just as importantly, Roth IRAs do not impose RMDs.
The tricky thing about a Roth conversion, though, is that the money you move into a Roth IRA is taxable that year. So if you have a large sum to move over, you may need to spread your conversion out over several years to avoid a massive IRS bill.
To that end, one window you may want to take advantage of is the period right after you stop working. At that time, Social Security benefits may not have started and withdrawals from savings can typically be controlled. You can keep your income low enough to cover your needs, giving you more leeway to convert funds to a Roth IRA at a lower tax rate.
Even once Social Security starts, you may still have a fairly low income relative to when you were working. So it’s important to figure out how much money you’re looking to convert to a Roth and give yourself the maximum number of years to move those funds before RMDs kick in.
For example, if, based on your year of birth, you’ll need to start RMDs at 75 and you retire at 65, you may decide to wait on Social Security for a couple of years. In that case, you may want to try to front-load your conversion and move a decent chunk of your savings into a Roth IRA between ages 65 and 67.
Then, once Social Security starts, you reduce your conversion amount but continue to gradually complete your Roth conversion between ages 68 and 74.
A solid plan makes the Roth conversion strategy more effective
A Roth conversion could spare you a giant tax headache in retirement, not to mention give you more control over your savings. But it’s important to plan for one carefully. By thoughtfully doing a Roth conversion over time, you can enjoy the benefits without unwanted tax consequences along the way.
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