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Required minimum distributions (RMDs) from pre-tax retirement accounts can have some unintended consequences. These mandatory withdrawals can push you into a higher tax bracket, reduce your investment flexibility, increase your Medicare premiums and cause more of your Social Security benefits to be taxed.
If you are considering converting your IRA funds to a Roth account, please consult with your financial advisor.
Converting a traditional IRA to a Roth account means you’ll avoid RMDs, but the fees are high. For example, moving $850,000 into a Roth IRA will trigger a large income tax bill in the year you do the conversion. There are ways to optimize this process, but there are still many uncertainties.
Tax rules require that you begin withdrawing certain amounts from pre-tax accounts such as traditional IRAs and 401(k)s each year starting at a certain age. For people who are now 65, RMDs will start at age 73. This is optional and stiff penalties apply if you don’t take RMDs exactly as prescribed.
Some people who already have enough income from other sources prefer not to take RMDs, though. Taxes triggered by RMDs are one of the main reasons for this reluctance. The additional income from RMDs can push you into a higher tax bracket and increase your tax bill.
For example, a single filer retirees with $60,000 in taxable income after deductions in the 22% bracket in 2024 and will owe approximately $8,250 in federal income tax. But if they have to take $50,000 RMD, their taxable income will almost double, putting them in the 24% tax bracket. This could make your tax bill more than double to about $19,400.
This tax impact is not the only problem. Having scheduled withdrawals reduces your control over your hard-earned savings. The added income can also increase your Medicare Part B premiums, and you may have to pay taxes on your portion of Social Security benefits. RMDs even affect estate planning, as having to withdraw funds and pay taxes will reduce the amount that can be left to beneficiaries.
But if you need some guidance planning or managing your RMDs, consider connecting with a financial advisor and talking it over.
Required minimum distributions (RMDs) increase your taxable income, increasing your tax bill in retirement.
With all of this in mind, you may want to consider converting your funds from a traditional IRA to a Roth account. This is possible because the Roth is exempt from the RMD rules.
However, conversion is not always the best strategy. One reason is that you have to pay taxes now on the funds you transfer to a Roth. If you convert the $850,000 balance to a Roth in 2024, you could pay over $267,000 in taxes.
But the different approach of rolling over IRA funds gradually over the years allows you to manage your annual tax hit and, potentially, lower your overall tax bill. Again, it’s not always the best move for everyone to talk to a financial advisor.
To find out if a Roth conversion works for you, first estimate your future income and taxes. For simplicity’s sake, let’s assume your current taxable income after deductions is about $50,000 per year and will remain at that level until you retire.
Now let’s estimate your RMD. Let’s assume your $850,000 IRA grows at 7% until you start RMDs at age 73. In that case, the IRS table sets the first year’s total withdrawal at about $55,000. This will reduce your annual income from $50,000 to approximately $105,000 and cause your tax bill to increase from $6,000 to $18,000.
Now consider doing a phased conversion with the goal of emptying your IRA by age 73. If you earn 7% a year and convert $132,000 a year, in eight years your IRA will be almost empty. Going forward, any Roth withdrawals you choose will be tax-free.
On the downside, annual conversions cause your taxes to increase. The current taxable income of $55,000 is added to the $132,000 in the Roth conversion resulting in income of $187,000. This pushes you to the top of the 24% bracket for single filers without crossing into the 32% tax bracket (which applies to income over $191,950).
However, you will pay about $25,000 in taxes on your first Roth conversion. While the tax rate will change after 2025, if you pay $25,000 a year for eight years, your total tax bill for the conversion will be around $200,000. That’s less than what you would pay if you converted the entire amount at once in a year. However, the question you want to answer is whether this is less than what you would pay in taxes if you left the money in the account pre-tax and took RMDs.
For a phased conversion to save you money in the long run, you need to calculate the amount of RMD required for cumulative income tax exceeding $200,000. These calculations can be complicated, so it’s best to have a financial advisor run these projections for you.
Once you determine that break-even point, you can determine how long you can expect to live.
A man looks through his retirement account on a laptop.
The main problem with Roth conversions is how you will pay taxes now. In your case, you can get $25,000 a year from other sources or use a portion of the converted funds to pay your annual tax bill (since you are over 59 ½). If you use modified funds, however, it reduces the size of the Roth account and the future ability to make tax-free withdrawals.
This strategy requires assumptions about earnings, income and taxes that may not work. For example, if you are taxed at a lower pension rate than you are now, which is not uncommon, you may be better off not converting now. Consider talking to a financial advisor before proceeding with this approach.
Converting funds from an IRA to a Roth can save you on taxes in retirement, but it will cost you money up front. You may be able to reduce your total taxable conversion by slowly rolling your pre-tax funds into a Roth account, but it’s not always the best move. There is considerable uncertainty when using this maneuver, including challenges to forecasting future income, investment returns and tax rates. You may be better off not converting and taking RMDs as required.
Social Security plays an important role in most people’s plans for retirement income. The age at which you claim your benefits can have a huge impact on your earnings prospects for the rest of your life. Claiming Social Security at age 62 will result in a 30% reduction compared to your full retirement age (FRA) of 67. Meanwhile, delaying Social Security will increase your benefits by 8% each year beyond your FRA. (up to the age of 70). SmartAsset’s Social Security calculator can help you estimate how much your benefits will be.
A financial advisor can help you evaluate the pros and cons of a Roth conversion. Finding a financial advisor doesn’t have to be difficult. SmartAsset’s free tool matches you with up to three designated financial advisors serving your area, and you can have a free introductory call with your advisor to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, start now.
Keep an emergency fund in case you run into unexpected expenses. An emergency fund should be liquid — in an account that isn’t at risk of significant fluctuations like the stock market. The tradeoff is that the value of liquid cash can be eroded by inflation. But high interest accounts allow you to earn compound interest. Compare savings accounts from these banks.
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