Should I convert the money in my traditional IRA account into a Roth IRA account to keep required minimum distributions (RMDs) low?
I'm 67 years old and retired, but I'm not collecting Social Security until I'm 70 years old. I'm collecting a pension and a spousal benefit from my ex-wife that I started at 66, so my income is low during the next few years. I'm staying under the $85,0000 limit to keep my Medicare costs from rising. Should I move the money in my traditional IRA accounts into a Roth IRA account so that I can keep my required minimum distributions (RMDs) low?
Moving, or converting, your tax deferred traditional IRA funds into a Roth IRA can give you many advantages in addition to eliminating your RMDs. Converting your traditional IRA (or at least a portion of these funds depending on what taxes could easily be paid on those dollars the year of conversion or over a series of years) into a Roth IRA is a simple solution. By converting your traditional IRA into a Roth IRA you will:
- Reduce your tax rate risk: The risk that taxes in the future could be higher than they are today. Once it is converted, any withdrawals from the Roth account after five years and achieving the age of 59.5 will be tax-free.
- Eliminate your Required Minimum Distribution (RMD): Once you turn 70.5 years of age the government requires you to take these funds out of your traditional IRA every year. If you forget or choose not to take these funds out of your traditional IRA, there is a 50% penalty. Whereas, with a Roth IRA there is no RMD.
- When withdrawing funds from your traditional IRA, the income counts as provisional income, whereas when withdrawing funds from your Roth IRA, the distributions have no Social Security tax. Roth IRA distributions do not count against income thresholds that may cause Social Security benefits to be taxed.
- Your heirs will receive your Roth funds tax-free.
- Roth IRA conversions may be re-characterized if your financial situation changes that year. Please note that as of 2018 with Trump's new tax law changes, all Roth IRA conversions done in 2018 and going forward may not be re-characterized back to your traditional IRA.
Converting from a traditional IRA to a Roth could be a useful tool. By paying taxes today you can take advantage of your current low income tax rate.
Read more: Tax Savings with a Roth IRA and Real Estate.)
It is fantastic that you recognize the opportunity in Roth conversions. The situation you have presented makes Roth conversions a very useful tax strategy. By lowering your RMDs you avoid your tax bracket being dictated by the set income you must take from tax-deferred investment vehicles each year. I agree wholeheartedly that you should convert as much as you can to fill up the 12% tax bracket over the next few years before your RMDs start. If you are able to convert enough, it is possible you can avoid having your Social Security benefits taxed when you begin receiving them, if you can not avoid complete taxation then maybe you can at least avoid 85% taxation. As you stated, be sure to avoid pouring into the next tax bracket and being taxed at a higher rate and increasing Medicare costs. Again, great job on recognizing the tax strategy of Roth conversions and the many benefits they can provide!
Great question! You've hit on a great tax saving strategy.
Yes, if you have a period of low income years, it's a great time to consider a Roth conversion strategy to take advantage of your low income tax rate. If you find you have room in a low tax bracket, it can make a lot of sense to convert enough of your Traditional IRA into a Roth IRA to "fill up" that low tax bracket. Not only will this reduce your RMD's in a few years, but if the funds are left to your heirs, they will be able to withdraw the money tax free!
As you mentioned, keep in mind the potential impact the conversion may have your Medicare premiums. Also, understand the impact on the taxability of your Social Security income before completing the Roth conversion.
Prior to 2018, you could recharacterize the Roth conversion up to October of the year following the conversion (basically, this means you could reverse the conversion and treat it as if it had never happened). With the new tax law, you can no longer recharacterize Roth conversions made after 2017. Therefore, you may want to wait until later in the year to determine the amount of the Roth conversion for 2018. This will give you a much better look at your 2018 income!
Best of luck to you!