Roth conversions of your traditional IRA or 401(k) accounts later in life tend to go against conventional wisdom, but depending on your financial situation, this one simple move could save you thousands of dollars in taxes during your retirement years.
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Take Brent Ehmke, a 72-year-old retired aerospace executive, for example. According to a recent article by The Wall Street Journal, the Plano, Texas resident realized he would soon have to take over $100,000 each year in required minimum distributions (RMDs) from his tax-deferred retirement account. This in addition to his other income from investments, Social Security, pension and consulting would result in a hefty tax bill.
“I’m asking myself, ‘Holy cow! Did I make a mistake? Did I wait too long?’” he said.
A Roth IRA is funded with post-tax dollars and you can enjoy tax-free withdrawals later. With a traditional IRA or 401(k), you fund the account with pre-tax dollars and pay taxes when you take distributions.
If you have adequate retirement income like Ehmke, doing a Roth IRA conversion of your 401(k) or traditional IRA might be a smart money move. Once you reach age 72 (73 if you reach age 72 after Dec. 31, 2022), you must take RMDs from your tax-deferred retirement account.
Yes, it does seem counterintuitive, paying taxes on distributions you’re not using just yet. When you roll over or transfer some of your funds from pre-tax dollars to a Roth IRA account, conversion rules mean that you will owe taxes. The amount you’ll pay is generally based on the amount you converted and where you fall on the income tax bracket.
But there are benefits since Roth IRAs don’t have RMD requirements while you’re alive and this could save you a significant amount on taxes.
Read more: Jeff Bezos and Oprah Winfrey invest in this asset to keep their wealth safe — you may want to do the same in 2024
Say you’re retired and the RMD amount plus your income coming in, whether it’s from a part-time job or dividends from other investments, is much more than what you need. Roth conversions could prevent you from being pushed into a higher tax bracket in the future. As the WSJ article notes, avoiding RMDs and keeping your income lower this way can also help prevent your Medicare premium rising or the 3.8% net investment-income surtax being triggered.
