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Roth Conversions for New Retirees

April 05, 2023

Many of us spend our working lives dreaming of retirement, a time where you can enjoy family, travel, and new hobbies. What some don’t realize is the first few months or even years of retirement can be a challenging time. There is a shift in your mindset from accumulation mode to withdrawal mode and learning how to best draw down accounts to optimize tax brackets. One of the best ways to have flexibility with tax rates in retirement is by having a withdrawal strategy and the flexibility of a Roth IRA.

If you were unable to save into a Roth account during your working years or want to continue increasing the size of your Roth bucket during retirement, you may be a great candidate for a Roth conversion.

For some new retirees, your income will drop in early retirement until age 73 when RMDs (Required Minimum Distribution’s) kick in. This gap to age 73 is when partial Roth conversions can be a great opportunity. Converting assets from a Traditional IRA to a Roth IRA and paying taxes in the same year.

If you enter retirement in a low tax bracket, it may be smart to fill up the 10%, 12%, 22% or 24% tax bracket. You are paying more taxes today to lower future RMDs and reduce your tax bill at age 73 and beyond. By filling these lower tax brackets early on, you are lowering your lifetime tax bill!

In addition to lowering your lifetime tax bill, you are building and growing a tax-free asset your heirs can inherit if you do not spend down all your assets in retirement. This can be a great estate planning strategy if your heirs will be in a high-income tax bracket when they inherit the money.

It’s not all sunshine and rainbows though, there are some other things to be aware of other than taxes. The increased income could have an adverse effect on Medicare premiums or make a portion of your Social Security taxable. Also, understanding the five-year rule, and aggregation rules with nondeductible contributions can be a deciding factor. It is important to consider all these factors before completing a Roth conversion.

One of the ways we balance the pros and cons with clients is by looking at a 10 to 15-year tax projection. This not only helps new retirees visualize where income will come from during retirement, but also the tax impact of each source. Projections are a great tool to understand the long-term tax impacts of Roth conversions in the early years.

If you are unsure if a Roth conversion makes sense for you or want to visualize the tax implications of a conversion, we are happy to meet.