65-Year-Old with $1.2 Million in IRA Considers Roth Conversion Despite Collecting Social Security: Is It Too Late?

65-Year-Old with .2 Million in IRA Considers Roth Conversion Despite Collecting Social Security: Is It Too Late?

A 65-year-old woman considers whether it makes sense to convert her $1.2 million IRA to a Roth IRA.

Imagine you’re 65 years old with $1.2 million in an IRA and a lingering question: Should you convert your account to a Roth IRA? The answer may depend on how you go about it. A Roth conversion can offer significant benefits, including tax-free withdrawals and no required distributions, but that doesn’t mean it’s always the right decision.

Although there is no prohibition or disadvantage to a Roth Conversion Depending on your age at 65, converting the entire $1.2 million at once will leave you with a larger tax bill than you would like to pay in a single year. If you use partial Roth conversions tailored to your situation, however, you can significantly reduce your tax burden and also plan for a tax-free inheritance later. If you need additional advice regarding Roth conversions and other retirement planning topics, speak with a financial advisor Today.

Roth IRA Conversion Concepts

A Roth conversion moves one’s retirement money Traditional IRA has a Roth IRA. Traditional pre-tax IRAs allow you to deduct contributions from taxable income when you contribute, but withdrawals in retirement are taxed based on your income tax bracket This year.

Roth IRA contributions use after-tax dollars, so you don’t get a tax break when you make contributions. However, qualifying withdrawals can be made tax-free later. Another big advantage is that Roth accounts are not subject to required minimum distributions (RMDs), which can put you in a higher tax bracket in retirement. Without an RMD, Roth funds can remain invested and grow tax-free forever, passing on to your heirs if it is part of your estate plan. There is also no income limit on Roth conversions, unlike direct contributions to a Roth IRA which can only be made by individuals with modified adjusted gross income (MAGI) less than $161,000 and by married couples filing jointly with MAGI less than $240,000 $.

But Roth conversions come with a significant pitfall. Money you convert in a given year becomes ordinary income in the year in which it is converted. That means paying taxes on that money – potentially a lot of it. Turning $1.2 million into taxable Roth conversion income could trigger the top federal rate of 37%, plus state taxes in most states. An alternative approach to reducing this potential tax impact is to do partial conversions, spreading a large amount over several years to avoid ending up in a higher bracket.

And if you want to discuss your options with an expert, consider using this free matching tool to find a financial advisor.

Lump sum or incremental conversions

A Roth conversion can provide tax flexibility in retirement.  However, this may not make sense to everyone. A Roth conversion can provide tax flexibility in retirement.  However, this may not make sense to everyone.

A Roth conversion can provide tax flexibility in retirement. However, this may not make sense to everyone.

As a single 65-year-old with $1.2 million in a traditional IRA, let’s assume you receive $24,000 in annual Social Security income, which is slightly more than the most recent average retirement benefit of $1,856 $ per month. If you converted the entire $1.2 million IRA balance to a Roth IRA in 2023 and took the standard deduction ($15,700 in 2023 for those 65 and older), all or almost all -entire converted amount could be subject to maximum tax rate of 37%. This could result in a one-time tax federal income bill of over $398,000 payable in April 2024, plus more if state taxes apply.

Need help with a Roth conversion? Find a financial advisor today.

There may be a better way, though. Spreading out the $1.2 million conversion over 10 years at $120,000 per year will put you in the 22% tax bracket in tax year 2023 after taking the standard deduction. That means paying about $18,430 in federal taxes per year on the converted portion. Over the decade, that totals about $184,300, for a total tax savings of about $214,000. (Although tax brackets change from year to year, we’re assuming you’ll stay in the 24% bracket for simplicity.)

People under the age of 59.5 should be aware of the five year rule during a Roth conversion. Withdrawing money from a Roth account less than five years after a conversion may result in a 10% penalty. However, this rule does not apply to people aged 59.5 or over, nor to those who benefit from certain exceptions.

More Considerations on Roth Conversion

There are other factors to keep in mind. On the one hand, adding taxable income from a Roth conversion can increase taxes on your Social Security benefits. You may also have to pay more Health insurance premiums and lose access to certain tax credits.

Additionally, the money you leave in the Roth in partial conversions will likely continue to grow, so you’ll need to convert more than $120,000 in subsequent years to empty the account. Additionally, future tax rates may increase. These uncertainties mean that any projection of taxes due under the phased conversion plan may differ significantly from the actual amounts you will owe. Converting everything now offers certainty: you will know exactly how much you have to pay.

Deciding if a Roth conversion is correct

A 65-year-old couple looks at their retirement savings and wonders if a Roth conversion is worth it.A 65-year-old couple looks at their retirement savings and wonders if a Roth conversion is worth it.

A 65-year-old couple looks at their retirement savings and wonders if a Roth conversion is worth it.

There are a lot of moving parts when evaluating a large Roth conversion. You may want to follow this process and speak with a Financial Advisor To better understand how this maneuver will affect your outlook:

  • Determine how you want to handle the IRA money when you die. If the goal is a completely tax-free inheritance, calculated partial Roth conversions can maintain this tax-free growth for heirs over time.

  • Compare current and expected future tax rates. Paying taxes now on a lump sum conversion or a series of larger conversions can ultimately save you money if tax rates increase in the future.

  • Consider other elements of your financial plan. Review your income streams, multi-year tax outlook, healthcare costs and estate plan. Choosing which Roth conversion method is best for you will likely require a careful and comprehensive analysis of your financial outlook.

Conclusion

Although you can do a Roth conversion at any age, converting an entire $1.2 million IRA to a Roth account in one fell swoop will typically hit you with a sizable tax bill. However, partial Roth conversions designed specifically for you can be a big help. Review your retirement spending plans, estate planning, healthcare budgets and more before opting for a conversion. Also consider potential changes to tax rates in the future and how they might impact you.

Retirement Planning Tips

  • A Financial Advisor can help you evaluate whether a Roth IRA conversion makes sense for you. Finding a financial advisor doesn’t have to be difficult. The free SmartAsset tool connects you with up to three licensed financial advisors who serve your area, and you can have a free introductory call with your advisor to decide which one seems best for you. If you are ready to find an advisor who can help you achieve your financial goals, get started now, gand I started now.

  • Smart assets Social Security Calculator is a quick and easy way to project your monthly check amount after you’ve claimed your benefits. If you are considering moving to a new state to retire, it is important to evaluate that state’s tax environment. Smart assets retirement tax allegiance The tool can help you do that.

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