Roth IRA Conversions at 67: Key Financial Considerations
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Considering a Roth IRA Conversion at Age 67
At 67, you’re likely approaching or already enjoying retirement. With $1 million in IRAs, converting to a Roth IRA may be attractive, as it can provide tax-free income in retirement.
Legal and Regulatory Considerations
It’s important to know that it's not too late to convert to a Roth IRA from a legal or regulatory standpoint. The IRS does not restrict Roth conversions based on age or income. If you have traditional IRA assets, you can convert them to a Roth. However, it’s crucial to remember that you won't be able to make a qualified withdrawal from a Roth IRA until five years after opening it. At this stage of life, there are significant financial tradeoffs to consider, including taxes, healthcare costs, and estate planning. Consulting with a financial advisor is advisable to determine if a Roth IRA conversion is right for you.
Understanding Roth IRA Conversions
How Roth IRA Conversions Work
A Roth conversion involves moving retirement savings from a traditional IRA into a Roth IRA. Traditional IRA contributions provide tax deductions, lowering your taxable income in the years you contribute. However, withdrawals during retirement are taxed as ordinary income based on your tax bracket at the time.
In contrast, Roth IRAs work the opposite way. Contributions are made with after-tax dollars, so they don’t lower your current taxable income. However, qualified withdrawals in retirement are completely tax-free. The catch with Roth conversions is that you must pay any taxes due at the time of conversion. This can be a significant concern.
Potential Tax Implications
For example, a 67-year-old couple converting their entire $1 million traditional IRA into a Roth IRA in a single year would owe income tax immediately on the entire converted amount. This could place them in the highest income tax bracket, with federal tax rates as high as 37%, plus state taxes of 5% to 13%, depending on location. Understandably, few people are eager to write a six-figure check to the IRS, but there are ways to make this less painful.
Roth IRA Conversion Strategies
All-at-Once Conversion vs. Staggered Conversion
Let’s consider what might happen if a retired 67-year-old couple with $1 million in a traditional IRA and average annual Social Security benefits of about $44,000 decides to convert to a Roth IRA. There are two primary approaches: converting all at once or spreading the conversion over time.
All-at-Once Conversion:
If they convert the entire $1 million IRA balance in a single tax year, they would incur federal and state income taxes that year on the full $1 million converted amount, placing them in the highest tax bracket. Total tax rates could approach 40% to 45%, resulting in a tax bill of $400,000 to $450,000.Staggered Conversion:
Alternatively, spreading the $1 million conversion over 10 years at $100,000 per year would mean owing income tax each year on $100,000. Assuming Social Security benefits and income tax brackets remain unchanged, they would be in the 22% federal tax bracket, owing $22,000 in federal tax on each $100,000 conversion. This approach would result in a more manageable total tax bill of $220,000 over 10 years—about half of the all-at-once approach.
This staggered strategy is beneficial if they don't need the money until later in retirement, as the account must age at least five years before making a qualified withdrawal. It may also be useful for leaving a tax-free inheritance.
Additional Roth IRA Conversion Considerations
Impact on Social Security, Medicare, and Estate Planning
Other factors may influence the decision to convert to a Roth IRA. Realizing conversion income could impact the taxation of Social Security benefits, Medicare premiums, and eligibility for certain tax credits like the Premium Tax Credit. Any Required Minimum Distributions (RMDs) from the traditional IRA must also be considered in multi-year projections.
Estate Planning Considerations:
If your plan is to leave your wealth to a charity, it may make more sense to leave funds in the traditional IRA rather than converting them, as the charity won’t owe taxes on the bequest. It’s also crucial to ensure that beneficiaries are correctly named on the Roth IRA and to evaluate the conversion’s impact on any trusts you have set up.
Making the Roth IRA Conversion Decision
Key Steps in the Decision-Making Process
If you’re considering a large Roth IRA conversion, follow these steps:
Clarify Your Goals:
Determine what should happen to the IRA assets upon death. If your goal is to leave an inheritance to heirs tax-free, strategic Roth conversions can ensure continued tax-free growth.Assess Tax Rates:
Evaluate your current marginal and future effective tax rates in retirement. If you anticipate higher tax rates in the future, converting now could save money later.Analyze Income Streams and Estate Plans:
Consider existing income streams, multi-year tax scenarios, healthcare budgets, and estate plans. For most people, a partial conversion strategy tailored to your needs will make the most financial sense.
Bottom Line
Once you reach 67, you still have the option to convert all or part of your traditional IRA assets to a Roth IRA. However, that doesn’t mean you should automatically do so. To decide if it aligns with your financial goals, assess your multi-year tax picture, compare current and future tax brackets, understand the total costs and implications involved, and choose a Roth conversion approach that suits your financial situation. Often, spreading conversions over time makes more sense than converting everything at once.
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