Retirees are often surprised by how much taxable income they must take from their retirement accounts once required minimum distributions (RMDs) begin. With the current RMD start age at 73, there may be opportunities to reduce future RMDs through strategic Roth conversions and RMD planning before those withdrawals become mandatory.
This article explores how Roth conversions can impact your RMD obligations, how timing plays a role, and what to consider when incorporating this strategy into a broader financial plan.
Understanding Required Minimum Distributions
RMDs apply to tax-deferred retirement accounts such as traditional IRAs, 401(k)s, and other qualified retirement plans. Once you reach age 73, you must begin taking annual withdrawals based on your account balance and life expectancy, as defined by IRS tables.
These distributions are taxed as ordinary income and cannot be delayed without penalty. The penalty for failing to take an RMD is currently 25% of the amount that should have been withdrawn, though it can be reduced to 10% if corrected in time.
As account balances grow over time, so do the RMD amounts. This can create higher-than-expected taxable income later in retirement—potentially affecting tax brackets, Medicare premiums, and Social Security taxation.
How Roth Conversions Enter the Picture
A Roth conversion involves transferring money from a tax-deferred account, like a traditional IRA, into a Roth IRA. You pay income tax on the converted amount in the year of the conversion, but the funds then grow tax-free—and qualified withdrawals in retirement are not taxed.
Importantly, Roth IRAs are not subject to RMDs during the account holder’s lifetime, which is why Roth conversions and RMD planning are often discussed together.
By converting part of your tax-deferred assets into Roth accounts before RMDs begin, you can reduce the balance of your traditional accounts, which may result in lower future RMDs.
When Might a Roth Conversion Make Sense?
Roth conversions don’t make sense for everyone, but in the right context, they can be part of a thoughtful plan to manage retirement income. Consider exploring conversions if:
- You expect to be in a lower tax bracket between retirement and the start of RMDs.
- You have a window of low taxable income (such as the early retirement years before claiming Social Security or receiving pensions).
- You want to reduce your future RMDs to help manage taxable income later.
- You’re planning for a surviving spouse, who may face higher taxes filing as a single individual.
- You want to leave tax-free assets to heirs who may be subject to the 10-year rule under the SECURE Act.
Each of these factors plays a role in determining whether Roth conversions might be appropriate within your financial plan.
Roth Conversions and RMD Planning: Timing and Tax Considerations
Timing matters when it comes to Roth conversions. Many retirees consider converting in the years after they stop working but before RMDs begin at age 73. This period can present a tax-efficient window for strategic conversions.
Some factors to consider when evaluating the timing of conversions include:
- Current tax bracket and how much income room is left before reaching the next bracket
- Future income expectations from Social Security, pensions, or annuities
- Medicare premium thresholds, which are tied to modified adjusted gross income (MAGI)
- State income taxes, which may also apply to conversions
Rather than converting a large amount in one year, many retirees consider spreading smaller conversions over several years to stay within a desired tax bracket.
Partial Conversions and Tax Bracket Management
One way to manage the impact of Roth conversions is to perform partial conversions. This means converting only enough to stay within a specific tax bracket. For instance, if you’re currently in the 22% federal tax bracket, you may choose to convert only up to the upper limit of that bracket.
This approach allows for more control over your annual tax bill while still reducing the size of your tax-deferred accounts over time. In turn, this may result in smaller RMDs and more flexibility in later years.
Planning for the Long Term
The relationship between Roth conversions and RMD planning is not just about minimizing taxes in one year—it’s about considering your tax exposure over the course of your retirement.
For example, someone in their mid-60s may project lower taxes over the next few years and higher RMDs in their 70s and 80s. By converting now, they pay taxes at today’s rates and potentially reduce taxable income later.
That said, it’s important to weigh the immediate tax cost of a conversion against the potential benefits down the line. Each individual’s situation is different, and personalized guidance can help assess the pros and cons based on your full financial picture.
Exploring Roth Conversions and RMD Planning
If you’re considering how to manage your future RMDs and are curious about the potential role of Roth conversions, now may be a good time to evaluate the possibilities. With thoughtful planning, it may be possible to create a more flexible income stream and support your long-term financial goals.
At Milford Financial, we can help you assess how Roth conversions and RMD planning fit into your overall retirement strategy. Reach out to explore whether this approach makes sense for your personal circumstances.
