Dear Liz: My husband and I both waited until age 70 to start Social Security. I will be 72 in September and am considering retirement. My husband is retired, 74, and taking required minimum distributions (RMDs). We have always tried to maximize contributions to our pre-tax retirement accounts and are now realizing the downside as we pay taxes on those mandatory withdrawals. Should I consider Roth conversions now or after I retire? I realize I will need to pay taxes on those conversions, but would it be best to do that when my income is lower? I am thinking about my kids and their future.
Answer: Late-in-life Roth conversions can be tricky. The amount you convert is removed from RMD calculations, lowering future tax bills. But the conversion is added to your current taxable income, potentially making more of your Social Security taxable and temporarily raising your Medicare premiums (thanks to income-related monthly adjustment amounts or IRMAA) in addition to generating a big tax bill.
Theoretically, a conversion could still make sense if your current tax rate is lower than the one you’ll have once you start required minimum distributions at 73. The case for conversion is strengthened if you want to pass this money to your kids. They likely would have to empty any inherited retirement account within 10 years, and they could be in their peak earning (and tax-paying) years when they do so. By converting now, you would in effect be paying the tax bill for them, perhaps at a lower rate than they might face, and allowing them to inherit the money tax-free.
A tax pro can help you with the calculations so you’ll understand the financial impact of a conversion. Then you can make an informed decision about whether to proceed.
The letter writer should also consider that they or their husband will eventually be a widow(er) and will be subject to the income tax “widow’s penalty”. Roth conversions now protect the survivor against some of that tax bite.