I’m 60 With $1.5 Million in My 401(k). Should I Convert $120,000 per Year to Avoid RMDs?

It’s a wise move to plan ahead for the taxes you’ll pay on retirement income, including eventual required minimum distributions (RMDs). Instead of waiting until the RMD deadline to start thinking about tax planning, starting the process at age 60 gives you the luxury of time to weigh all of your options and adjust your strategy as you go. 

A big consideration in retirement is how to minimize the tax bite the IRS takes out of money you’ve saved in tax-deferred retirement accounts like IRAs or 401(k) plans. Contributions to those plans aren’t taxed when the money goes in, which maximizes your compounded gains over time. When money is withdrawn, it’s taxed as ordinary income. And once the investor turns 73 (or 75 for those who turn 74 after Dec. 31, 2032) the IRS demands that a specific portion of the money is cashed out so that the government can start collecting taxes on the money that’s been long socked away. 

So why does this all matter? If a retiree also is collecting Social Security, a pension or other income, the additional money from an RMD can push them into a higher tax bracket and also can trigger taxes on their Social Security benefits. That’s why planning well in advance can be so beneficial.

Imagine that you’re 60 years old with $1.5 million in your 401(k), which gives you 14 years before your first RMD is due (the IRS allows you to delay your first mandatory withdrawal until April 1 of the year after you reach RMD age). Over those 14 years, you could convert your entire 401(k) balance into a Roth IRA. Roth accounts aren’t subject to RMDs and because taxes are paid at the time of conversion, qualified withdrawals can be made penalty- and tax-free. Handled correctly, you can minimize taxes on your retirement money while sidestepping RMDs and completely avoid taxes on any new gains earned in your converted Roth account. 

There are two important caveats, though. First, you can withdraw contributions to a Roth IRA at any time, but you must wait five years after making your first Roth contribution to withdraw investment gains free of taxes and penalties. When executing a Roth conversion, you must wait five years before you can withdraw the converted principal (unless you’re age 59 ½ or older) and avoid the 10% early withdrawal penalty.

The five-year waiting period is dictated by what’s known as the five-year rule. A financial advisor can help you better understand and navigate this complicated rule so you can avoid unwanted tax bills and early withdrawal penalties.

Looking at the specifics of your situation, you might want to adjust your strategy. As a single-filer, converting $120,000 in a year would keep you well below the 2024 $182,100 upper limit of the 24% tax bracket as long as you make $62,100 or less in other taxable income. Any more, and you’ll move into incrementally larger tax liability.

If you were to convert up to the limit for the 22% bracket – which is $95,375 for 2024 – for 14 years, you’d reduce the tax bite by 2% for a portion of the conversion. Remember, you’ll have to also account for any gains on money left for longer in your IRA. And over 14 years, there may be changes to tax rules, so plan on adjusting your approach as necessary.

The size of the chunk of IRA cash you can convert each year will vary, according to your investment returns. In down years, converting up to your maximum bracket limit might move 20% of your money into a Roth where, once reinvested, that money can produce higher gains as the market recovers. In years when your investments gain, you’ll convert a smaller percentage of your IRA balance. Over the course of 14 years, the effect of those conversions will serve to average out your tax bill. 

Planning on how to handle taxes and withdrawals from your retirement nest egg is best done early in retirement, or even before you stop working. This allows you to consult with professionals, weigh all the options and still have time to adjust your strategy to whatever challenges life throws at you. 

• As you can see, RMDs can play a pivotal role in the income taxes a retiree will potentially owe. Knowing how much your first RMD will be and when it’s due is an important first step in the planning process. SmartAsset’s RMD calculator can help you estimate how much
• A financial advisor can help you create a tax strategy for retirement withdrawals. 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.
• Keep an emergency fund on hand in case you run into unexpected expenses. An emergency fund should be liquid — in an account that isn’t at risk of significant fluctuation like the stock market. The tradeoff is that the value of liquid cash can be eroded by inflation. But a high-interest account allows you to earn compound interest. Compare savings accounts from these banks.

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