Using Roth Conversions in Retirement

Using Roth Conversions in Retirement

Taking Advantage of Low-Income Years in Retirement

There are many reasons why your taxable income could be lower in the earlier years of your retirement. Potential reasons can include:

During this timeframe, it may make sense to accelerate your income to take advantage of these lower tax years by performing something called a Roth IRA conversion.

What is a Roth Conversion?

A Roth IRA conversion allows you to turn your traditional IRA or other pre-tax retirement accounts into a Roth IRA because you’re taxed as if you took a withdrawal equal to the amount of the conversion.

A Roth IRA is different from a traditional IRA in that contributions are made with after-tax dollars, grow tax-free, and qualified Roth distributions are free of federal income tax. 

Performing Roth conversions in your lower-income years, allows you to potentially decrease your total tax liability throughout your retirement. They can also, reduce your future RMDs, and give you more flexibility with your future withdrawal strategies because qualified distributions aren’t included in your taxable income.

In addition, Roth IRAs can be used for legacy planning since they can provide tax-free withdrawals to your heirs. 

The “Filling Up Your Bracket” Roth Conversion Approach

One way to implement Roth conversions during your pre-RMD low-income years is known as the “filling up your tax bracket” strategy. This approach allows your Roth conversion to be potentially more tax-efficient when compared to a single lump sum conversion. 

In this strategy, you convert an amount that allows you to remain in your current marginal tax bracket for that year. These smaller conversions spread the tax liability over multiple years and reduce the average tax rate you’ll pay on the amount converted.

Roth Conversion Example

For example, in 2021 the 22% tax bracket for a married couple filing jointly ranges from $81,051 to $172,750. If you file a joint return and your taxable income is $120,000, that means that you could add around another $50,000 of income without going into the next bracket or triggering any IRMAA surcharges.

Note: It is recommended before making any conversion, you consult with your tax professional.

Incorporating Roth Conversions into Your Financial Plan

Although Roth conversions can be a useful tactic in retirement, their benefits are unlikely to be fully realized without having a long-term plan in place. Being able to project your taxable income throughout retirement, allows you to spot the years where Roth conversions may be most useful.

*Tax tables are subject to change, which could disrupt any potential tax planning strategies.

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