I’m 60 and Make $150k. Should I Convert $50k per Year From My IRA to a Roth to Avoid RMDs?

There are plenty of ways to analyze your retirement strategy. Sometimes, when we have lots of concrete information, we can start by running the numbers. If X, then Y, and the next steps are to decide what risks and outcomes you’re comfortable with.

But sometimes, the place to start is with questions. As you build a retirement strategy, it’s important to know… well, what’s important. What kind of information do you need? How will you use that information to build a specific, dollars-and-cents plan? 

To understand that, let’s look at a fairly vague scenario. Say that you’re 60 years old. You have a comfortable, $150,000 per year income and are considering a staggered Roth conversion to avoid the need to take taxable required minimum distributions from your account in your 70s and beyond. But this means you’ll take extra tax hits now while you’re still working. What do you need to know to decide if this plan will work?

This should be the first question with any financial plan. What are you trying to do?

Here, you’re looking to make a staggered Roth conversion $50,000 at a time. The idea here is to avoid RMDs by moving money from an account that requires RMDs (your IRA) to an accoun that is exempt from RMDs (a Roth IRA). But why?

For example, are you looking to preserve your retirement account for your heirs? Are you looking to minimize income taxes? Do you simply want to reduce complexity in your retirement income?

While avoiding RMDs with a Roth conversion may lead to lower taxes in retirement, we raise this issue because avoiding RMDs might not always be your best option. It can be the right move, such as if you’re trying to build a maximum-value estate. But in other cases, such as minimizing taxes, you might actually spend more than you’re likely to save in some cases. This can depend on factors like your tax bracket now and in retirement, the size and growth of your account, and more. 

So start here. Don’t just identify the financial tools and techniques you’re using. Figure out exactly what you want that financial tool to achieve. 

Most retirement plans will include income from Social Security. This isn’t because those benefits will necessarily make up a majority of your income, but because they’re the most predictable part. Starting in retirement, the government guarantees you a minimum income for life if you’ve met the qualifications. So you can start planning there.

So the first number to look at is, what benefits will you receive? 

Here, you earn $150,000 per year. That can give us a sense of your potential Social Security. Based on the SSA’s quick benefits calculator, if you wait seven years and collect at full retirement age you might collect about $3,315 per month in today’s dollars. If you wait until age 70, you might collect about $4,202 per month.

But the calculator is back-of-envelope. It makes a lot of assumptions about your earning history, some or all of which might be inaccurate. For your own planning, use the SSA’s full benefits calculator which can run the numbers based on your actual work credits. 

Knowing your benefits will tell you what kind of baseline income to plan around, which in turn will help you plan investments around a strategy of growth vs. retention. For example, the higher your benefits, the more you might save with a tax-free Roth account. On the other hand, the lower your benefits, the more you might want to preserve your investment capital for future growth. 

Next, we need to look at the structure of your retirement portfolios. What are they? For example, do you have a 401(k)? An IRA? Both? Or do you have a 403(b), or a pension? 

This is the second question to ask. 

Here, we know you already have an IRA. Do you have other assets? For example, would you be supplementing an existing Roth portfolio, or would you be converting your IRA to a newly-created Roth? 

What, if any, other retirement accounts do you have? If you make $150,000 per year, is that as a W-2 employee? If so, do you have a 401(k) or other employer-funded portfolio?

How you answer this question can change your approach to an IRA conversion significantly. For example, in general a Roth conversion has minimal gains for a household in or entering retirement. However, if you will use this Roth portfolio for supplemental income, that can change the math significantly. So, whether you have a 401(k) or not is an important question. The same is true if you currently have a well-funded Roth. If you are already planning on taking significant tax-free income, it might be worth paying some conversion taxes to plan for an entirely tax-free retirement.

Now, finally, we get to the heart of the matter. How much money do you have? This will significantly determine how your conversions work, and what kind of benefits you see. For example, a few important issues that will be defined by your portfolio assets include: 

• How will this affect your taxes?
• How many years will a full conversion take?
• Do you need to plan around RMDs at all?

For example, depending on your goals (see above) you may not need to plan around RMDs at all. If your income needs exceed those requirements, you’re going to withdraw this money anyway. 

Take our case here. You make $150,000 per year. In general, most retirees need about 80% of their pre-retirement income to maintain their standard of living, so say $120,000 per year in combined income. Our quick estimate already gives you almost $40,000 per year from Social Security, giving an $80,000 per year portfolio drawdown. Your RMDs will not exceed that unless you have more than $2.1 million in pre-tax investments at age 73.

This isn’t always the end of the analysis, to be sure. Your savings may well exceed that tipping point, and if you have assets spread across several pre-tax portfolios you will need to pay attention to withdrawals at all times. But it’s worth making sure that RMDs aren’t a financial paper tiger.

Speaking of taxes, make sure you plan around the tax event of a conversion. 

Here, $50,000 staggered conversions would mean the difference between $150,000 per year and $200,000 per year of taxable income. This would raise your taxes by an estimated $12,324 per year. It’s best to make sure this tax tradeoff will be worth the benefit of avoiding RMDs in the long run.

Answering these questions will help you decide whether the cost of conversion is worth the benefits. Making a financial plan depends on knowing your goals and assets. In other words, what do you want to do and what are you trying to do it with? For example, if you’re looking at a Roth conversion, start with these four questions to decide if it’s really worth it.

• Is your Roth conversion worth it? A Roth conversion is one of the trickier issues in retirement planning. It has huge back-end benefits, no income taxes, set against a pretty hefty up-front cost, conversion taxes. So, now that we’ve looked at the questions, let’s start diving into the answers. 
• A financial advisor can help you build a comprehensive retirement plan. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.

Photo credit: ©iStock.com/Rockaa