Planning for retirement is a critical part of securing your financial future, and minimizing taxes is often a key component of that planning. If you’re 64 years old with $650,000 in a traditional IRA, you might be wondering whether converting some or all of that money to a Roth IRA could help you avoid Required Minimum Distributions (RMDs) and reduce your tax burden in retirement. Here’s a summary of the key points to consider, along with practical advice, to help you make an informed decision.
Understanding the Problem with RMDs and Taxes in Retirement
When you save for retirement using a traditional IRA or a 401(k), you’re required to start taking RMDs once you reach a certain age—73 for most people (or 75 if you turn 74 after December 31, 2032). RMDs are withdrawals from your pre-tax retirement accounts, and while they’re mandatory, some retirees prefer not to take them if they don’t need the income. The issue arises because RMDs are taxable, and when added to your other income, they can push you into a higher tax bracket, increasing your overall tax liability.
For example, suppose you have $650,000 in a traditional IRA at age 64, and your account grows at an average annual rate of 7%. By the time you’re 75, your IRA could be worth around $1.37 million. That means your first RMD could be approximately $95,000. If you already have $75,000 in taxable income from other sources and you’re single, that $95,000 RMD could push you from the 22% tax bracket to the 24% bracket, increasing the amount of taxes you owe. A financial advisor can help you navigate these challenges and explore strategies to reduce your tax burden.
How Roth Conversions Can Help
One effective strategy to minimize the impact of RMDs is to convert some or all of your traditional IRA funds into a Roth IRA. Roth accounts are not subject to RMD rules, so converting your IRA to a Roth can help you avoid those mandatory withdrawals and the associated taxes on unwanted income in retirement. Additionally, Roth accounts offer tax-free growth, meaning your investments can grow over time without being subject to taxes.
However, there’s a trade-off: converting a large IRA balance, such as $650,000, all at once would trigger a significant tax bill in the year of the conversion. For instance, if you’re a single filer and you convert the entire $650,000 in one go, you could end up paying around $193,000 in taxes (not including any other income taxes you may owe). That’s a hefty upfront cost, but it could save you money in the long run by avoiding higher taxes later on.
Gradual Conversions: A Strategic Approach
To avoid a massive one-time tax hit, you might consider gradually converting your IRA funds into a Roth IRA over several years. The idea is to convert just enough each year to keep your taxable income within your current marginal tax bracket. For example, if you have $75,000 in taxable income and you’re in the 22% bracket as a single filer, you could convert $28,350 from your IRA without crossing into the next tax bracket (which tops out at 24% for 2025). By spreading out the conversions, you can manage the timing and amount of taxes you pay, giving yourself more financial flexibility.
While you’re gradually converting your IRA to a Roth, the remaining funds in your IRA will continue to grow. However, by the time you reach age 73, your IRA balance will be smaller, which will reduce the amount of your RMDs. This can help you avoid unnecessary withdrawals and keep more of your retirement savings working for you.
Estate Planning Benefits of Roth Conversions
In addition to reducing your own tax burden, converting your IRA to a Roth can also be beneficial for estate planning. When you pass away, your heirs will inherit your Roth IRA tax-free, meaning they won’t have to pay taxes on the withdrawals. This can be a powerful way to leave a legacy for your loved ones while minimizing the tax impact on their inheritance.
Important Considerations and Trade-offs
While Roth conversions offer significant benefits, they’re not without their challenges. For one, the five-year rule applies to Roth conversions: you must wait five years after converting funds to withdraw them without facing a 10% early withdrawal penalty. However, this rule doesn’t apply if you’re 591⁄2 or older, so it’s less of a concern in your situation.
Another consideration is whether your tax rate is likely to increase or decrease in retirement. If you expect to be in a higher tax bracket after you retire, converting now could save you money in the long run by locking in your current lower rate. On the other hand, if you expect to be in a lower tax bracket in retirement, it might make more sense to keep your funds in a traditional IRA and pay taxes on withdrawals later. A financial advisor can help you assess your situation and determine the best approach.
Calculating RMDs and Planning Ahead
To better understand how RMDs might impact you, it’s helpful to calculate what your RMDs might look like. The IRS uses a life expectancy factor, which you can find on the Uniform Lifetime Table, to determine your RMD each year. For example, at age 73, the life expectancy factor is 26.5. If your IRA balance is $1.37 million at that age, your RMD would be approximately $51,735 ($1,370,000 divided by 26.5). Tools like SmartAsset’s RMD calculator can give you a clearer picture of what to expect.
The Role of a Financial Advisor
While it’s possible to handle some of this planning on your own, working with a financial advisor can be incredibly valuable. They can help you determine whether a Roth conversion strategy makes sense for you, how much to convert each year, and how to balance your tax burden with other retirement goals. A financial advisor can also help you explore other tax-saving strategies, such as charitable donations, tax-loss harvesting, or adjusting your withdrawal schedule.
Final Thoughts
Deciding whether to convert your IRA to a Roth is a personal choice that depends on your unique financial situation, tax outlook, and retirement goals. By gradually converting your IRA over several years, you can minimize your tax burden, avoid unwanted RMDs, and create a more flexible retirement income plan. While there are trade-offs to consider, such as the upfront taxes on conversions, the long-term benefits of tax-free growth and estate planning can make the strategy well worth exploring.
If you’re unsure where to start, consulting with a financial advisor can provide clarity and help you make the most of your retirement savings. With careful planning, you can ensure that your hard-earned money works for you—not just during your working years, but well into retirement.
