Income Planning
Post-Retirement Roth Conversion
It can make sense to convert a traditional IRA to a Roth IRA even after retirement.
Many people believe it doesn't make sense to convert a traditional IRA to a Roth IRA late in life. In reality many retirees have a longer life expectancy than you might expect. What's more, a partial or complete conversation can provide significant tax savings even if the owner of the IRA has only a very short life expectancy. The benefits aren't present in all cases, so careful analysis is required to determine whether a rollover makes sense, how much to roll over, and when. As explained below, in most cases the rollover will make sense if all of the following are true:
You'll take only qualified distributions from your Roth IRA, so that all your withdrawals are free from taxes and penalties.
You'll be able to pay taxes on the rollover from another source. In other words, you won't use money from the IRA to pay taxes. (Sometimes you can benefit even if this is not true.)
Most importantly, you won't pay tax on the rollover at a significantly higher rate than the rate that would apply if you left the money in your regular IRA, taking it out when you need it later in life. To avoid this problem you may need to do only a partial rollover.
Potential Benefits:
A post-retirement rollover may permit you to accomplish one or more of the following:
Have a larger dollar amount invested in a tax-free vehicle by using other savings to pay tax on the rollover.
Keep your money invested in a tax-free vehicle for a longer time by avoiding required distributions after age 70½.
Cause the money in your regular IRA to be taxed at a lower rate than if your children inherited the IRA.
Reduce or eliminate tax on your social security benefits.
Reduce your estate tax by paying income tax on your IRA before you die.
We'll take a closer look at these benefits, then turn to some important points concerning possible detriment.
Increasing the Size of Your IRA
Moving money from a traditional IRA to a Roth IRA has a hidden, but very favorable consequence: it increases the amount of money you have in your IRA. The dollar amount is the same, but the effective amount is larger. This is because the Roth IRA contains only after-tax dollars. Part of your traditional IRA will end up going to Uncle Sam when you cash out, so it's almost as if you don't own the entire IRA. The better your investment performance, the more tax you end up paying. That's not true for a Roth IRA. Because this feature of the Roth IRA is so important — and hidden — we have a separate page devoted to this point.
Avoiding Required Distributions
Having more money than you need in retirement is a nice problem to have. But that doesn't mean it isn't a problem, if you reach age 70½ and still don't want to take money out of your IRA. If the tax rules force you to take a distribution you don't need, you're losing the benefit of tax-free compounding when you could otherwise be living on other savings. The Roth IRA provides a way to extend the benefits of IRA investing for as long as you can afford to leave the money in the account, and that can mean more wealth for your later years — or for your heirs.
Reducing the Tax Rate on Distributions
If you have reason to believe there will be a substantial amount left in your IRA when you die, you may wish to consider the tax rate that will apply to the benefits. Unless the IRA will be consumed by your spouse, it may pass to children or other heirs while they're in their prime earning years, and therefore in a higher tax bracket than you are. Rolling to a Roth IRA now may avoid having that income taxed at the higher rates that apply to your beneficiaries.
Reducing Tax on Social Security Benefits
If you're receiving social security benefits in the year of the conversion, you may find that the conversion causes you to include more of those benefits in income for that year. Yet many people will end up with overall savings here. The annual distributions you receive from a traditional IRA increase your income. Depending on your income level, this could cause part of your social security benefit to be taxable, year after year throughout your retirement. There's a possible one-time hit with the conversion, but after that you may fly under the radar for the tax that might otherwise apply to your annual social security benefits.
Distributions you take from a Roth IRA don't count as "tax-exempt income" that goes into the calculation of how much of your social security benefit is taxable.
It can make sense to convert a traditional IRA to a Roth IRA even after retirement.
Many people believe it doesn't make sense to convert a traditional IRA to a Roth IRA late in life. In reality many retirees have a longer life expectancy than you might expect. What's more, a partial or complete conversation can provide significant tax savings even if the owner of the IRA has only a very short life expectancy. The benefits aren't present in all cases, so careful analysis is required to determine whether a rollover makes sense, how much to roll over, and when. As explained below, in most cases the rollover will make sense if all of the following are true:
You'll take only qualified distributions from your Roth IRA, so that all your withdrawals are free from taxes and penalties.
You'll be able to pay taxes on the rollover from another source. In other words, you won't use money from the IRA to pay taxes. (Sometimes you can benefit even if this is not true.)
Most importantly, you won't pay tax on the rollover at a significantly higher rate than the rate that would apply if you left the money in your regular IRA, taking it out when you need it later in life. To avoid this problem you may need to do only a partial rollover.
Potential Benefits:
A post-retirement rollover may permit you to accomplish one or more of the following:
Have a larger dollar amount invested in a tax-free vehicle by using other savings to pay tax on the rollover.
Keep your money invested in a tax-free vehicle for a longer time by avoiding required distributions after age 70½.
Cause the money in your regular IRA to be taxed at a lower rate than if your children inherited the IRA.
Reduce or eliminate tax on your social security benefits.
Reduce your estate tax by paying income tax on your IRA before you die.
We'll take a closer look at these benefits, then turn to some important points concerning possible detriment.
Increasing the Size of Your IRA
Moving money from a traditional IRA to a Roth IRA has a hidden, but very favorable consequence: it increases the amount of money you have in your IRA. The dollar amount is the same, but the effective amount is larger. This is because the Roth IRA contains only after-tax dollars. Part of your traditional IRA will end up going to Uncle Sam when you cash out, so it's almost as if you don't own the entire IRA. The better your investment performance, the more tax you end up paying. That's not true for a Roth IRA. Because this feature of the Roth IRA is so important — and hidden — we have a separate page devoted to this point.
Avoiding Required Distributions
Having more money than you need in retirement is a nice problem to have. But that doesn't mean it isn't a problem, if you reach age 70½ and still don't want to take money out of your IRA. If the tax rules force you to take a distribution you don't need, you're losing the benefit of tax-free compounding when you could otherwise be living on other savings. The Roth IRA provides a way to extend the benefits of IRA investing for as long as you can afford to leave the money in the account, and that can mean more wealth for your later years — or for your heirs.
Reducing the Tax Rate on Distributions
If you have reason to believe there will be a substantial amount left in your IRA when you die, you may wish to consider the tax rate that will apply to the benefits. Unless the IRA will be consumed by your spouse, it may pass to children or other heirs while they're in their prime earning years, and therefore in a higher tax bracket than you are. Rolling to a Roth IRA now may avoid having that income taxed at the higher rates that apply to your beneficiaries.
Reducing Tax on Social Security Benefits
If you're receiving social security benefits in the year of the conversion, you may find that the conversion causes you to include more of those benefits in income for that year. Yet many people will end up with overall savings here. The annual distributions you receive from a traditional IRA increase your income. Depending on your income level, this could cause part of your social security benefit to be taxable, year after year throughout your retirement. There's a possible one-time hit with the conversion, but after that you may fly under the radar for the tax that might otherwise apply to your annual social security benefits.
Distributions you take from a Roth IRA don't count as "tax-exempt income" that goes into the calculation of how much of your social security benefit is taxable.
