Given that investment accounts are about to finish a very good year and current tax rates are unlikely to change for a while, it’s hard to justify paying taxes now to convert traditional IRAs and 401(k)s into Roth accounts.
However, one financial advice platform, Boldin, saw a 128% increase in usage of its Roth conversion calculator in 2024 over the previous year.
Boldin, formerly known as NewRetirement, hears from all types of users who saved well in tax-deferred accounts during their working careers and now, as they approach retirement, see the looming required minimum distributions as a problem.
“They’re realizing it,” said Steve Chen, CEO of Boldin. “Most of our users are 401(k) millionaires, over age 50, and they are starting to realize that it’s not just about profitability, it’s about where their money is.”
Required minimum distributions are the IRS version of delayed gratification. You can set aside money each year that grows tax-free in qualified accounts while you work, but at some point you’ll have to start paying taxes on that money. Right now, that point is 73, but in 2033 it will go to 75. There is a formula the government applies based on your age and your account balance to determine how much you should withdraw.
The problem for 401(k) millionaires who are 50 years old (or younger) is that during the 20 years or so before they have to start withdrawing money, they can accumulate $4 million with compound growth, even at a modest growth rate . That would mean an RMD of at least $150,000, which counts as taxable income. With Social Security and other investment gains taxed (along with wages, for those still working at age 73) that will push them into higher tax brackets than they would have assumed they would be in. Additionally, they will likely end up paying IRMAA Surcharges on their Medicare premiums.
If you are likely to withdraw more than necessary from your qualified retirement accounts each year for living expenses, then you generally won’t be bothered with your RMDs and Roth conversions are not for you. If you’re worried that your savings won’t last you a lifetime, then it’s not worth considering whether to tax now or later.
Concerns about RMDs are generally only for people who have large balances in tax-deferred accounts that will more than cover their needs. The idea is that you systematically withdraw large sums from your accounts, convert that money to a Roth account, and pay the tax due with other savings so you don’t reduce the amount you’ve set aside for future tax-free growth by paying the tax on the withdrawal. same. What are considered large sums could be anything between $25,000 and $200,000 each year for several years, said Nicholas Yeomans, a Georgia-based certified financial planner.
It is optimal to make this type of conversion when you are in the 24% or lower tax bracket and believe your rate will increase in the future, either because you anticipate that your income or the tax law may change. It’s also best to do it when financial markets are down, so you pay less taxes and can capture the growth spurt in the Roth, where it will occur tax-free and where there are no looming RMDs for you or your heirs to worry about.
However, that is not the situation at the moment. The stock market has risen sharply this year and the incoming Trump administration, with the help of Republicans in the House and Senate, is likely to reduce tax rates or expand current rates.
“I don’t think people had that on their bingo cards 45 days ago,” said Stash Graham, a Washington, D.C.-based asset manager.
But that doesn’t mean Roth conversion activity has stopped. On the contrary, the situation has generated alternative arguments to achieve it. For one, your RMD amount is locked in by your account balance as of December 31, and many people will face higher RMDs next year due to this year’s earnings.
Graham also noted that whatever happens in the next few years in terms of tax legislation won’t last forever, and may not even last longer than a typical multi-year Roth conversion strategy, which could be 10 years. What happens in the next two years could be surpassed by changes in seven or eight years.
“We are still advising customers, especially younger customers, that if their future earning potential is greater, let’s go ahead and convert now,” Graham said. “If you want to do this conversion, it’s probably cheaper to do it now than later.”
Graham said he just had this conversation with a recently retired wealthy client in his 60s who was thinking about his upcoming RMDs. The best time to begin these types of conversions is usually before age 63, when additional income may trigger Medicare IRMAA surcharges.
The customer may have been a little late, but he wasn’t thinking about himself. He intended to leave that money to his children, and he wanted to rip off the Band-Aid and do a major conversion so they wouldn’t be saddled with an inheritance that they would have to pay taxes on for over 10 years at his high rates. . His thinking was this: he used to be in the low 30% tax bracket, and now he was in a much lower one, certainly lower than what his children would pay. “It’s a unique event and he feels like he can absorb it,” Graham said.
Graham’s task was to take this plan, do the math, and compare it to alternatives, such as spreading the conversions over five years or more, or donating some of the money.
Another multi-tiered strategy is what Yeomans used with a client who used the tax savings from a large charitable gift to cover the tax impact of a Roth conversion. Most of the time, this works best with a qualified charitable gift from an IRA, which allows you to donate up to $105,000 and have it satisfy one RMD and reduce next year’s RMD (this amount will increase to $108,000 in 2025, as QCDs are now indexed to inflation). You have to be at least 70½ years old to do this.
However, many clients have large stock positions in brokerage accounts, perhaps due to company options or due to an inheritance. As they grow, cashing them in creates a tax burden, so one solution is to donate those shares directly to a charity or put them in a donor-advised fund to distribute later. If you accumulate a few years of planned giving, you can probably itemize your Schedule A expenses instead of taking the standard deduction.
“We identify how much tax savings the gift would generate, then we reanalyze what type of Roth conversion would eliminate those tax savings,” Yeomans said. The effect is that the client can do a Roth conversion, be generous, generate no capital gains, and end up paying no additional taxes. “We are also reducing future RMDs,” Yeomans added. “It’s a great strategy that gets overlooked.”
Do you have questions about investing, how it fits into your overall financial plan, and what strategies can help you make the most of your money? You can write to me at . Please write “Repair my wallet” in the subject line.
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