I’m 62 with $1 million in a 401(k). Should I Convert $100,000 Per Year to a Roth IRA to Avoid RMDs?

By | March 4, 2024

A 62-year-old woman calculates how much she would pay in taxes on a $100,000 Roth conversion.

A 62-year-old woman calculates how much she would pay in taxes on a $100,000 Roth conversion.

Retirees with significant assets often need to plan around required minimum distributions (RMDs).

If you already have sufficient income and don’t need the money in a pre-tax portfolio, annual RMDs can cost you significantly in otherwise unnecessary taxes. For example, let’s say you have $1 million in a 401(k). The IRS may require you to withdraw tens of thousands of dollars from this account each year, causing the entire amount to be taxed. For households that do not yet need that money, this can lead to an unnecessarily high tax burden.

A financial advisor can help you plan RMDs and make other important decisions surrounding your retirement. Find a fiduciary advisor today.

Moving your money into a Roth IRA can save you on those taxes in retirement because this money has already been taxed and is not subject to RMDs. However, making that transfer will significantly increase your taxes upfront, so it’s important to make sure it won’t actually cost you more money in the long run.

What are RMDs?

Required Minimum Distributions (RMDs) Required Minimum Distributions (RMDs)

Required Minimum Distributions (RMDs)

Required minimum distributions, or RMDs, are a feature of pre-tax retirement accounts such as 401(k)s and traditional IRAs.

Beginning at age 73, individuals with pre-tax retirement accounts must withdraw a minimum amount each year. This rule applies per account. For example, if an individual owns both a 401(k) and an IRA, they would be required to make minimum withdrawals from both accounts each year. Each year’s RMD amount depends on the value of the individual account and the age of the holder.

RMDs are designed to trigger a load event. As with all pre-tax withdrawals from a portfolio, RMDs are taxed as ordinary income. The IRS wants individuals to ultimately pay taxes on the income saved in these portfolios, so it requires that you make at least some withdrawals in retirement. For this reason, RMDs do not apply to Roth IRA and Roth 401(k)s.

RMDs can significantly increase a household’s taxes. For example, suppose you are 80 years old and have a $500,000 IRA that you don’t currently need to support your lifestyle and expenses. The IRS nevertheless requires you to withdraw $24,752 from this account, all of which counts toward your taxable income for the year. Not only will you owe taxes on this money, but you will also have to choose between selling the assets (and sacrificing future growth) or raising the tax money from another source. Keep in mind that a financial advisor can help you calculate how RMDs will affect your tax situation and how to best deal with them.

Manage RMDs with Roth Portfolios

A 62-year-old man nearing retirement smiles as he thinks about his future. A 62-year-old man nearing retirement smiles as he thinks about his future.

A 62-year-old man nearing retirement smiles as he thinks about his future.

Roth IRAs are not subject to RMD rules, so converting a pre-tax account to a Roth portfolio is generally the easiest way to avoid minimum distributions.

For example, let’s say you’re 62 and have a $1 million 401(k). Excluding contributions and withdrawals, at an 8% growth rate this portfolio could be worth $2.33 million at age 73. The IRS would require you to withdraw $87,924 from that account that year, putting an individual near the top of the 22% tax bracket. even before taking into account any income from Social Security and other retirement portfolios.

In contrast, if you were to hold this money in a Roth portfolio, you could leave it in place until you needed it. It can be set aside for later in life and continue to grow without withdrawals or taxes.

The biggest problem with a Roth conversion is that in exchange for tax savings later, you have to pay income taxes now. Any money you convert into a Roth IRA must be included in that year’s taxable income. For example, let’s say you earned $100,000 in 2024 and converted $1 million from your 401(k) to a Roth IRA in the same year. Your taxable income for 2024 would be $1.1 million, which amounts to almost $360,000 in federal income taxes, assuming you take the standard deduction.

To manage this you can perform a so-called staggered or gradual conversion. Instead of rolling over your entire portfolio, you can transfer some of it at a time. This way you can ensure that you never receive a higher tax bill than you can handle each year and that you do not end up in a higher tax bracket. If you’re over age 59.5, you can also cash out some of your account to raise money for those taxes. This would obviously reduce your savings for retirement.

For example, say you earn $100,000 a year and have $1 million in your 401(k) at age 62. If you make $100,000 a year in sales, you increase your taxable income to $200,000 a year and pay about $38,000 in federal income taxes. At age 73, you would probably still have a significant amount of money in your 401(k), because account growth would partially offset your conversions, but you would have the $1 million in an account that is free of both taxes and RMD requirements . But if you need more help estimating your tax liability and the impact of RMDs, consider talking to a financial advisor.

Before you do a Roth conversion

Be careful of two things.

First, Roth contributions cannot be withdrawn five years after they are made. This five-year rule applies to each conversion separately. So if you do a series of staggered conversions (one per year), you’ll have to wait five years after the first conversion to withdraw that money, another five years to withdraw money from your second conversion, and so on. Violating this rule will result in taxes and a 10% fine.

Second, these taxes will increase. Each year you pay income taxes on the money you convert to your Roth IRA. Depending on your tax bracket when you make these conversions, your upfront taxes may be higher than the income tax you would pay on the minimum distributions in retirement. Consider talking to a financial advisor to make sure it will actually benefit you in the long run, because if you’re not careful, this strategy could cost more than it saves.

In short

Graduated conversions from a 401(k) to a Roth IRA can reduce or eliminate the need for required minimum distributions (RMDs) while also saving you money on each year’s tax bill. However, if you’re close to retirement, make sure your upfront taxes don’t cost more than the distribution taxes at retirement.

Tips for Managing RMDs

  • The IRS only requires that you make required minimum distributions at the end of each year. When and how you make these withdrawals is up to you, so make sure you structure these distributions to get the maximum benefit out of them.

  • A financial advisor can help you create a comprehensive retirement plan that takes into account your RMDs and their tax impact. Finding a financial advisor does not have to be difficult. SmartAsset’s free tool matches you with up to three vetted financial advisors serving your area, and you can have a free introductory meeting with your advisors to decide which one you think 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/PeopleImages, ©iStock.com/Nastassia Samal, ©iStock.com/ferrantraite

The post I’m 62 with $1 million in a 401(k). Should I Convert $100,000 Per Year to a Roth IRA to Avoid RMDs? first appeared on SmartReads by SmartAsset.

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