With investment accounts about to end a very good year and current tax rates unlikely to change for a while, the case for paying taxes now to convert traditional IRAs and 401(k)s to Roth accounts is hard to make.
Boldin, formerly known as NewRetirement, hears from all sorts of users who saved well in tax-deferred accounts during their working careers and now, as they approach retirement, see looming required minimum distributions as a problem.
“It’s dawning on them,” said Steve Chen, Boldin’s chief executive. “Most of our users are 401(k) millionaires who are 50-plus, and they are starting to be aware that it isn’t just about returns — it’s where your money is located.”
If you are likely to take out more than you are required to from your qualified retirement accounts each year for living expenses, then you won’t generally be mad about your RMDs, and Roth conversions aren’t for you. If you’re worried that your nest egg won’t last through your lifetime, then contemplating whether to tax now or tax later isn’t worth your time.
Concerns about RMDs are typically only for people who have big balances in tax-deferred accounts that will more than cover their needs. The idea is that you systematically withdraw large sums out of your accounts, convert that money to a Roth account, and pay the tax due with other savings so that you don’t reduce the amount you have set aside for future tax-free growth by paying the tax with the withdrawal itself. What counts as large sums could be anything from $25,000 and $200,000 each year for several years, said Nicholas Yeomans, a certified financial planner based in Georgia.
It’s optimal to do this kind of conversion when you’re in the 24% tax bracket or lower and you think that your rate will increase in the future, either because you anticipate your income or tax law may change. It’s also better to do it when financial markets are down, so that you are paying less in tax and you can capture the upswing in growth in the Roth, where it will happen tax-free and where there are no looming RMDs for you or your heirs to worry about.
However, that isn’t the situation right now. The stock market is up sharply for the year, and the incoming Trump administration, with the help of Republicans in the House and the Senate, is likely to either lower tax rates or extend the current rates.
“I don’t think people had that on their bingo cards 45 days ago,” said Stash Graham, an asset manager based in Washington, D.C.
But that doesn’t mean Roth conversion activity has halted. Conversely, the situation has made an alternate case for getting it done. For one thing, your RMD amount gets locked in by your account balance as of Dec. 31, and many people will be facing higher RMDs next year because of gains this year.
Graham also noted that whatever happens in the next few years in terms of tax law won’t last forever — and perhaps not even past the length of a typical multi-year Roth conversion strategy, which might be 10 years. What happens in the next two years could be overtaken by changes in seven or eight years.
“We are still advising clients, especially younger clients, that if their future earning potential is higher, let’s go ahead and get your conversion done now,” Graham said. “If you want to make this conversion, it’s probably cheaper to do it now, rather than later.”
Graham said he just had this discussion with a recently retired wealthy client in his mid-60s who was thinking about his coming RMDs. The prime time frame to begin these types of conversions is usually before age 63, when additional income might lead to Medicare IRMAA surcharges.
The client was perhaps a little late, but he wasn’t thinking about himself. He intended to leave that money to his kids, and he wanted to rip the Band-Aid off and do a major conversion so they wouldn’t be saddled with an inheritance they’d have to pay tax on over 10 years at their high rates. His thinking was this: He used to be in the low-30% tax bracket, and he was now in a much lower one — certainly lower than what his children would be paying. “It’s a one-time event and he feels like he can absorb it,” Graham said.
Graham’s task was to take this plan and run the math on it and compare it against the alternatives, like stretching out the conversions over five years or more, or giving some of the money away.
Another multilayered strategy is one that Yeomans used with a client who used the tax savings from a large charitable donation to cover the tax hit of a Roth conversion. Most of the time, this works best with a qualified charitable donation from an IRA, which allows you to give away up to $105,000 and have it satisfy an RMD and lower next year’s RMD (this amount will go up to $108,000 in 2025, as QCDs are now indexed for inflation). You have to be at least 70½ to do this.
Many clients have large stock positions in brokerage accounts, however, perhaps from company options or because of an inheritance. As they grow, cashing them in creates a tax burden, so one solution is to donate that stock directly to a charity or putting it in a donor-advised fund to distribute later. If you bunch up a few years of intended donations, you’ll likely be able to itemize your Schedule A expenses instead of taking the standard deduction.
“We identify how much tax savings the donation would generate, then we back into what kind of Roth conversion would wash out that tax savings,” Yeomans said. The effect is that the client is able to do a Roth conversion, be generous, generate no capital gains and end up paying no extra taxes. “We’re also bringing down future RMDs,” Yeomans added. “It’s a great strategy that’s overlooked.”
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