Top 5 Reasons to Consider a Roth Conversion if You are Over 50

You likely have a traditional 401(k) and a traditional IRA account. You may even have a Roth 401(k) or Roth IRA account. If you are over 50 and nearing or in retirement, you might be considering converting additional money from a traditional IRA to a Roth IRA. Here are the top 5 reasons to consider a Roth conversion if you are over 50.

Tax diversification

Tax rules and rates change over time. Having most or all of your retirement savings in traditional retirement accounts means that withdrawals in retirement will be subject to taxes at your ordinary income tax rate.

A Roth conversion offers tax diversification as you move through retirement. As long as you are over age 59 ½ and have satisfied the five-year rule, withdrawals can be made tax-free from your Roth account.

This tax diversification allows you a higher degree of planning flexibility when it comes to your distribution strategy in retirement and your tax planning.

Reduce future RMDs

A big advantage offered by Roth IRA accounts, but not for a Roth 401(k) account, is the fact that there are no required minimum distributions (RMDs). This can have several positive planning ramifications.

First, of course, RMDs are taxed. If you don’t need this money during retirement, converting some or all of a traditional IRA or 401(k) to a Roth IRA can make sense. The amount converted to a Roth IRA will not be taxed via RMDs.

Not having to take RMDs can also allow the money in the Roth account to continue to grow tax-free. This money is available for tax-free withdrawals during retirement as needed as long as the five-year rule is satisfied.

The lack of an RMD requirement also allows the money in the Roth account to accumulate tax-free for the account beneficiaries, both spousal and non-spousal.

Estate planning

Roth IRAs have several advantages when it comes to estate planning. As mentioned above the sheer fact that no RMDs are mandated allows the balance in the account to grow for the account beneficiaries.

The SECURE Act legislation that went into effect at the beginning of 2020 changed the rules as far as inherited IRAs for most non-spousal IRA beneficiaries. For IRAs inherited before January 1, 2020, the account beneficiary could withdraw the money via RMDs based on their own life expectancy or that of the original account owner. Especially for younger beneficiaries than the original account holder, this allowed the beneficiary to stretch the inherited IRA by taking the RMDs based on their own longer life expectancy.

The SECURE Act changed this for most non-spousal beneficiaries. The SECURE Act mandates that these beneficiaries who do not fall into the eligible designated beneficiary classification must withdraw the entire balance of an inherited IRA account within 10 years.

In the case of an inherited traditional IRA, this could mean a significant tax hit for some beneficiaries compared with the old stretch IRA option for inherited IRAs before the SECURE Act. This can be especially true for adult non-spousal beneficiaries who are in their peak earning years during this ten-year period.

This change in the inherited IRA rules could be a good reason to consider a Roth conversion. An inherited Roth IRA will still fall under the new 10-year rule. However, beneficiaries of a Roth IRA can withdraw the funds from an inherited Roth IRA tax-free as long as the original account holder had met the five-year rule before their death.

Lower-income year

You may have years past age 50 where your income is lower than normal. If you are still working, perhaps your income varies in some years due to bonuses, commissions, or other forms of variable compensation. Or maybe you own a business, and it is having an off-year, causing your income to be lower than normal.

A lower-income year can present an opportunity to do a Roth conversion at a lower than normal tax rate making your conversion more tax-efficient.

Higher tax bracket in retirement

It is not uncommon to find yourself in a higher tax bracket in retirement, or at least one that is as high as when you were working. This could result from a pension, taxable distributions from retirement accounts such as an IRA, Social Security benefits, part-time work, or other sources of income.

Considering a Roth conversion before commencing pension and Social Security payments or other income streams that could drive you into a higher tax bracket in retirement can make sense from a couple of perspectives.

First, money converted to a Roth IRA will not need to be withdrawn in retirement unless needed. These withdrawals will be tax-free as long as the five-year rule is satisfied. Second, doing the Roth conversion before your income increases in retirement will be more tax-efficient than doing it later on when you are retired if your income level in retirement is indeed higher.

Things to consider before doing a Roth conversion

A Roth conversion can be a solid financial planning option for those who are over 50. However, you will need to weigh the benefits of converting against the cost of the conversion, namely the taxes that will need to be paid in the year of the conversion.

A general concern with doing a Roth conversion over age 50 is whether or not you will have sufficient time to recover from the upfront tax hit. In doing a Roth conversion for estate planning reasons, it’s important to look at things from a total family tax perspective.

A Roth conversion is a financial planning tool. Like any financial planning tool, it’s important to look at both the benefits and the pitfalls of doing a Roth conversion, especially if you are over 50.

As independent, fee-only financial advisors, we will help you assess whether or not a Roth conversion is the best strategy to help you accomplish your goals in retirement. Want to hear more- CLICK HERE for our Roth Conversion Podcast.


Have A Question? CLICK HERE