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A 62-year-old with $1.5 million in a traditional IRA may be wise to consider converting $150,000 per year to a Roth IRA to avoid required minimum distributions (RMDs). The annual withdrawals from retirement accounts that are mandated by RMD rules can raise your tax bill in retirement by adding to your taxable income, even if you don't need or want the income to cover your expenses.
Strategic Roth conversions allow you to distribute RMD-susceptible IRA money into accounts that aren't subject to RMDs. You'll have to pay taxes now on any money that gets converted but the move can reduce overall lifetime taxes and improve predictability. Speak with a financial advisor to get expert guidance on retirement planning strategies personalized to your situation.
RMD Rules
The Internal Revenue Service requires account holders to start taking RMDs from IRAs, 401(k)s and other tax-deferred retirement accounts at age 73. RMDs represent the minimum amount that must be withdrawn each year based on account balances and life expectancy.
While the SECURE 2.0 Act moved the RMD age back to 73 for people who turned 72 after Dec. 31, 2022, the RMD age will increase to 75 for people who reach age 74 after Dec. 31, 2032. This means a person who's 62 in 2024 won't face RMDs for another 13 years.
Each RMD withdrawal adds to your taxable income for that year, which can push you into higher tax brackets. While it's natural to want to avoid that, RMDs are not optional and failing to take them as dictated can subject you to steep financial penalties.
If you need help calculating your RMD amount or want to explore ways to avoid them altogether, speak with a financial advisor.
Roth Conversion Strategy
A Roth IRA can provide a way out. Roth accounts aren't subject to RMD rules and funds within an IRA can be converted into a Roth account. With this in mind, many savers with money in IRAs and similar accounts are interested in Roth conversions and thereby avoid the potential tax implications of RMDs.
There is a catch, however. Traditional IRAs hold pre-tax money that is taxed when it's withdrawn. Roth withdrawals are tax-free, but when you convert money from a pre-tax account to a Roth, you have to pay income taxes now on all the funds you convert.
Despite this, it turns out that paying taxes on smaller conversions now can result in lower lifetime taxes overall compared to unpredictable RMDs later. You just don't want to convert too much too fast. That can hike your near-term tax bills unnecessarily.
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