We are 67 years old and have $1 million in IRAs. Is it too late to switch to a Roth?

By | March 18, 2024

At age 67, you are probably at or near retirement. If you have $1 million in IRAs, it may be attractive to switch to a Roth because it can provide tax-free income in retirement.

From a legal or regulatory perspective, it is not too late. The IRS does not restrict Roth conversions based on age or income. If you have existing traditional IRA assets, you can convert them. You can’t make a proper withdrawal from a Roth for five years after you open it, but if you have existing traditional IRA assets, you can convert them. However, when you make this decision later in life, notable financial considerations surrounding taxes, healthcare costs, estate planning and more come into play. Ask a financial advisor if Roth IRA conversion makes sense for you.

Understanding Roth IRA Conversions

A Roth conversion moves retirement savings from a traditional IRA account to a Roth IRA account. Traditional IRA contributions offer tax deductions, which reduce your taxable income each year you contribute. But traditional IRA withdrawals made during retirement are taxed as ordinary income based on which tax bracket you are in at the time.

Roth IRAs work in the opposite way. Contributions are made using after-tax dollars, so you don’t reduce your current taxable income with contributions. However, qualified withdrawals later in retirement are completely tax-free. The downside to conversion is that when you do one, you have to pay all the taxes that are now due on the money you convert. This is not an insignificant concern.

A 67-year-old couple who converted their entire $1 million traditional IRA to a Roth version in one year would immediately owe income taxes on the entire converted balance. This income would also put them in the highest income tax bracket. Tax rates can be as high as 37% at the federal level, plus applicable state taxes ranging from 5% to 13%, depending on your location. Of course, few people are eager to write a six-figure check to the IRS, although there are ways to make this less painful.

Talk to a financial advisor to discuss your options for rollovers and retirement planning.

Roth IRA Conversion Specifications

Let’s look at what might happen if a retired 67-year-old couple with $1 million in a traditional IRA and an average combined annual Social Security benefit of about $44,000 decide to roll over to a Roth IRA. There are two ways to do this, all at once and over time.

If they chose to convert the entire $1 million IRA balance to a Roth IRA in one tax year, they would have to pay federal and state income taxes on the entire $1 million converted amount that year, putting them in the highest income tax bracket. Total ordinary tax rates can be as high as 40% to 45%, or $400,000 to $450,000 on a $1 million conversion.

That’s the all-in-one approach. By taking their time and spreading the $1 million conversion over 10 years at a conversion of $100,000 per year, they would only owe income tax on $100,000 each year. Assuming that Social Security benefits and income tax brackets remain unchanged for this example, they would fall into the 22% federal tax bracket. They would owe $22,000 in federal tax on every $100,000 conversion, a much more manageable bill. Additionally, the total tax over ten years is $220,000, which is about half of the all-in-one approach.

Keep in mind, however, that this strategy is only worthwhile if they don’t need the money until late in retirement, because they’ll need to age the account for at least five years before they can make a decent withdrawal. This can be useful if they want to leave a tax-free inheritance.

They would still owe taxes on their Social Security benefits in each of those ten years. But diverting some savings to the Roth IRA provides some future tax-free income capacity that can be drawn upon to offset taxes due later on traditional 401(k) or IRA withdrawals. Conversion diversification allows them to prudently minimize their total lifetime tax liability. It also creates a pool of tax-free estate money if they end up gifting part of the Roth account to children or grandchildren.

You can work with a financial advisor to explore your options for minimizing taxes and maximizing retirement income.

Additional Roth IRA Conversion Considerations

Other factors can also weigh on a significant Roth IRA conversion decision. For example, realizing the conversion income could affect taxation of Social Security benefits, Medicare premiums and eligibility for certain tax credits, such as the premium tax credit. Any required minimum distributions (RMDs) already taking place on the existing traditional IRA should also be factored into multi-year projections.

Real estate plans must also be taken into account. For example, if you plan to leave all your wealth to charity, it probably makes sense to leave the money in the traditional IRA rather than converting it to a Roth because the charity will not owe any taxes about the legacy. You should also make sure that the Roth beneficiaries are named correctly and that you evaluate the impact of the conversion on any trusts you have set up.

Talk to a financial advisor today about estate planning.

Making the Roth IRA Conversion Call

If you are considering a major Roth conversion, consider the following process:

First, clarify what should happen to the IRA’s assets upon death – if the goal is to leave an inheritance to heirs entirely tax-free, then making calculated Roth conversions can ensure continued tax-free growth.

Then assess current marginal and future effective tax rates in retirement. If rates are likely to rise substantially due to changes in tax law, paying taxes now through a conversion can save money later.

Finally, analyze existing income streams, multi-year tax scenarios, healthcare budgets and estate plans.

In most cases, you will ultimately choose not to convert everything at once. For those with large traditional IRAs, strategic partial conversions tailored to your needs often make the most financial sense. A financial advisor can help you weigh your options.

In short

In summary, once you reach age 67 or older, you can still convert all or part of your traditional IRA assets to a Roth IRA. However, that doesn’t mean you should. To decide if this is right for your situation, assess your multi-year tax picture, compare current and future tax brackets, understand the overall costs and implications, and choose a Roth conversion approach that fits your specific financial situation. Converting everything in one year often does not make as much sense as spreading conversions over time.

Tips

  • A financial advisor can explain how a Roth IRA conversion would impact tax bills, estate planning, healthcare costs and more. SmartAsset’s free tool matches you with up to three financial advisors in your area, and you can interview your advisors for free to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.

  • Plug your numbers into SmartAsset’s Social Security calculator to get an idea of ​​how much your benefits will be after you retire.

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