Are Roth IRA conversions advisable after age 70 ½? What are the five things you need to be thinking about? I’ve talked often about how Roth conversions can be a very effective strategy when you’re in your 60’s, in that sweet spot between retirement age and age 70 ½ (when you have to do your Required Minimum Distributions. But what about after age 70 ½?
Before getting into that, though, I want to be clear on something. When you when you take money out of an IRA after age 70 ½, the first dollar out has to go towards your required minimum distribution (RMD). Starting the year you turn 70 ½, you cannot do a Roth conversion until you satisfy your required minimum distribution amount. That would be an impermissible transaction. You have to take the RMD first, and then do the Roth conversion.
I pull these five tips about whether Roth conversions are advisable after age 70 ½ from my colleague, Ed Slott, a CPA in New York who has been on More Living several times in the past.
Number 1: When will the funds be needed? Remember, Roth IRAs are only beneficial in the long run if your tax bracket when you pull the money out of the Roth is higher than it was when you did the conversion. Tax rates in the future, when you pull money out of the Roth, are likely to be higher than what they are now. So, time is an important factor here. If you convert your money, you’ve got to pay this upfront tax. If you need to pull that money out of your Roth IRA in three or four years, you don’t have enough time to recoup that expense. When will you need the funds?
Number 2: What are future tax rates going to look like? Are your tax rates potentially going to be higher in the future? Looking down 10 to 15 years, there’s concern about budget challenges and our deficits. A new report from the Wharton College of Business says Social Security will be broken by 2032. Therefore, Roth conversions may be an effective strategy to hedge the risk of much higher tax rates 10 to 15 years from now. And remember, Roth conversion is not an all-or-nothing choice. You can do partial Roth conversions with your money. It’s a great way to hedge future tax rate increases.
Number 3: What are your beneficiaries projected tax rates? When you leave money to your beneficiaries, any money in a retirement account is taxed at the beneficiary’s tax rate. Any distribution taken from a retirement account after the account owner’s death, the beneficiary is taxed on their tax return. What if your kids have much higher tax rates than you? That can be an important part of your plan. Now, doing Roth conversions is an upfront cost to you, but it may help you pass it on more efficiently to them.
Number 4: What about qualified charitable distribution (QCD) planning? Once you’re 70 ½, as part of your RMD, you can give money directly to church or charity and it’s a page one deduction that comes straight off of your RMD taxation. If you’re doing qualified charitable distributions, that’s tax-free distributions from your IRA. Therefore, you may more room to do a Roth conversion after you’ve satisfied your RMD requirements because a portion of the RMD, if not all of it, was not taxable.
Number 5: What about medical bills? Roth conversions may need to be avoided if you have large, unreimbursed medical bills because, even under the new tax law, these expenses are still deductible as itemized deductions. If they exceed 7.5% of your adjusted gross income (going up to 10% next year), RMD income can be partially offset by these medical deductions. But, if you do Roth conversion, you’re going to increase your adjusted gross income, which will then decrease the amount of the deductible medical expenses.