Experts suggest that leveraging a limited window of time could lead to tax savings when considering a Roth individual retirement account (IRA) conversion. This type of conversion allows for the transfer of pretax or nondeductible IRA funds to a Roth IRA, which then enables tax-free growth in the future. The trade-off, however, is the requirement to pay upfront taxes on the converted balance. The decision to convert a pretax balance depends on various factors, with converting early in retirement considered beneficial as it can reduce the upfront tax bill when income is lower.
The ideal time for Roth conversions is believed to be after stopping work but before starting required withdrawals from retirement accounts, known as “the sweet spot”. This strategy allows for potentially maximizing the benefits of Roth conversions during lower income years. Additionally, taking advantage of lower income tax brackets until 2025, before potential changes from former President Donald Trump’s tax overhaul, can also be advantageous. Following a Roth conversion, regular income taxes are owed on the converted amount, with the tax bracket depending on the taxable income for that year.
One significant benefit of Roth conversions is the reduction of taxable retirement balances subject to future required minimum distributions (RMDs). Unlike traditional IRAs, Roth IRAs are not subject to RMDs, providing flexibility in retirement planning. Furthermore, by converting to a Roth IRA, taxes for heirs who inherit the account can be eliminated. With the implementation of the “10-year rule” for inherited accounts, most adult children must deplete the account within 10 years, potentially triggering tax issues for heirs during peak earning years.
However, it is important to consider the impact of Roth conversions on Medicare premiums, particularly due to the potential increase in income resulting from the conversion. The income-related monthly adjustment amounts (IRMAA) for Medicare Part B and Part D premiums are based on modified adjusted gross income (MAGI), which includes adjusted gross income plus tax-exempt interest. As there is a two-year lookback period, income from a Roth conversion could push an individual into a higher bracket, increasing Medicare premiums significantly. Crossing the MAGI limits can result in a substantial jump in Medicare premiums, emphasizing the importance of careful planning and consideration when deciding on a Roth conversion.
