When you turn 72 (age 70.5 if born before July 1, 1949), you are required to withdraw funds from your traditional IRA. The amount, your Required Minimum Distribution (RMD), is calculated based on your age and account balance. This distribution, like all other withdrawals from a Traditional IRA, is taxable. Roth IRAs on the other hand, do not have this requirement, as they are already funded with after-tax dollars.

What does a Roth Conversion allow me to do?

Many of our clients opt to process Roth Conversions to reduce the balance of an IRA subject to RMDs. Processing Roth Conversions in advance of RMDs allows you to smooth your effective tax rate and can help mitigate substantial tax liability down the road. When clients retire, it’s not always into a lower tax bracket – pensions, IRA distributions, social security, and investment income could inflate your tax rate. This is amplified by RMDs over and above your spending needs.

What should I convert?

The entire IRA balance does not need to be converted all at once. You’re able to convert any amount, over any number of years. It may be favorable to convert a portion of your IRA account in years when income is lower or when income tax deductions are higher. For example, if you made a large charitable contribution or incurred significant medical expenses, you could offset the increased deduction with income from a Roth Conversion. Often, the ideal time to process a Roth Conversion is in the years between retirement and the start of required minimum distributions.

The Process

To process a Roth Conversion, funds are withdrawn from your traditional IRA account and rolled directly into a Roth IRA account. You’ll owe income taxes on the conversion amount, but all future growth is tax free. Qualified Roth IRA withdrawals are not taxed; you or your beneficiaries will receive distributions tax free.  Paying the taxes on your IRA now, at historically low rates, may save you and your beneficiaries taxes over the long run.

It is important to assess all financial implications when considering a Roth IRA conversion.  The conversion could trigger a higher tax bracket, certain tax deduction phase outs and Medicare premium surcharges.  We can help examine the total financial impact of a conversion.

Roth Conversions are a great income tax planning tool, so are you ready to Roth?