Help Me Retire Podcast - Episode 33
- 5 hours ago
- 7 min read
The "Golden Window" for Roth Conversions
Show notes:
I call it the “golden window” for Roth IRA conversions... are you in it? And if so... how can you take advantage of this golden opportunity? On this episode of The Help Me Retire Podcast...
This is the Help Me Retire Podcast… with your host… Mike Brown… Senior Wealth Advisor with Raymond James Financial Services… and head of Brown Family Wealth Advisors…
Mike is the best-selling author of Your Way to True Wealth: How to Make It Happen, Make It Last, and Make It Matter…
He and his team have been helping clients pursue their dreams of financial independence for the past 30 years… and in the Help Me Retire Podcast… he’ll share his best ideas with you…
And now… here’s Mike…
So, you know what we’re talking about here... converting traditional IRA money... into a Roth IRA...
And you’re saying... that’s where I pay taxes now before I have to... so I can pay less later, right?
That’s correct... but it’s not the whole story...
A lot of folks think retirement is the end... of tax planning... but in reality... retirement is when tax planning becomes even more important... because once you retire... you gain more control over your income...
In retirement... you get a lot of say in where your taxable income comes from... when to start your pension... when to take Social Security... when to sell investments and realize capital gains... and the big one... when... and how much... to pull from your traditional IRAs... and what to do with it...
Traditionally... you can take IRA distributions beginning at age 59-and-a-half... and avoid the 10-percent penalty for early withdrawal... you still pay taxes on those distributions... but the penalty goes away at 59-and-a-half...
And at age 73... the IRS makes you start taking money out of your IRA every year and pay taxes on it... those are called required minimum distributions... or RMDs...
Between those two ages... 59-and-a-half and 73... you can take as much out of your IRA as you want without penalty... or as little as you want... if anything at all... it’s entirely up to you...
So, why would you want to take IRA distributions... and pay taxes on that income... before the IRS says you have to?
Good question... and the answer has to do with how big those RMDs are likely to be when you reach age 73...
Some people discover... to their shock and dismay... that their RMDs are bigger than they’d planned... they’ve got to take their own money out... more than they might need to live on... pay taxes on it at whatever tax bracket they’re in... and then figure out what to do with it...
And that’s your business... after you pay those taxes... you can spend it... you can save it... you can give it away... it’s up to you...
But one thing you can’t do with your RMD... is put it into a Roth IRA... where it could be invested tax-free for the rest of your life...
So, let’s say you retire at age 65... just one example...
Your RMDs start the year you turn 73... so that’s an eight-year period you can move money from traditional to Roth IRA...
We call those years... the golden window... for Roth conversions... and in just a second... I’m going to give you more information so that you can determine if the Golden Window is right for you and your situation...
What’s so golden about this window... between the year you retire... and the year you turn 73?
Well, think about it this way...
Once you retire... you’ve got more time to think about stuff like this... you’ve got time to think... not only about how much tax you’ll pay this year... but how much you’ll be paying each year for the rest of your life...
That’s going to depend on where your income comes from... and once you retire... as I said earlier... you’ve got a lot more control over that...
Once you stop getting that paycheck every other Friday... you might see a pretty significant drop in income... especially if you haven’t started taking Social Security yet...
In fact... if your income is lower... the taxes you pay on that income might logically be lower as well... you might even find yourself in a lower tax bracket...
So, how can you take advantage of the golden window... those years between retirement and RMDs... when your tax rate might be lower than when you were working?
Think about converting some of your traditional IRA money into a Roth IRA... not just once... maybe do a conversion every year until those RMDs start... spread out the tax bill over those years...
How much should you convert? Ah... there’s the key question...
Remember... Roth conversions will result in taxable income... you’re paying taxes before you have to... in order to pay less in the future... but the good news is that you get to decide how much...
Tax advisors often recommend a strategy called... filling the bracket... and this can be a little tricky... because you have to make an educated guess about what your income is going to be by the end of this year... and then calculate how much more income you could add before you hit the next tax bracket...
The number you come up with... is what you might consider for a Roth conversion...
And what if you convert too much and go into a higher bracket?
Well, the bad news is... the IRS won’t let you reverse it... they used to, but not anymore... once you do a conversion... you can’t change your mind and back it out...
The good news... is that you won’t get taxed at the higher rate on the entire Roth conversion... just the amount that goes over into the higher bracket...
And the even better news... is that you can do more than one Roth IRA conversion in a year... so maybe you come up with a target number and convert something less than that early in the year... then late in the year... once you’ve got a good idea what your total income is going to be... you do a second Roth conversion to fill up the rest of your current tax bracket.
The simplest approach might be just to wait until the fourth quarter of each year and do the conversion then... once you’ve got a better estimate of this year’s income...
Just don’t wait until the last minute... a lot of IRA custodians won’t process Roth conversions in the last half of December... because they can’t guarantee everything will get done by the 31st... so give yourself a little cushion...
Coming up... some final pointers... some mistakes to avoid... and a five-step checklist you can use each year... to potentially take full advantage of the golden window for Roth conversions...
A few more things to keep in mind when you’re thinking about doing a Roth IRA conversion...
The first is... you’re going to be taxed on the conversion... it’ll be added to your income in the year you do it... so how will you pay those taxes?
You could withhold taxes on the amount you convert... but that will mean you won’t get the full benefit of the conversion... so if at all possible... try to pay taxes from someplace else... a taxable account... cash reserves...
That way... the full amount... every dollar you’re paying taxes on... will end up in the Roth IRA where you want it...
Next thing to remember... is what impact this extra income is going to have on things other than taxes...
Too much extra income in a given year... could make more of your Social Security benefits taxable... it could trigger the IRMAA surcharge... meaning you pay more for Medicare...
And more income could limit some deductions you would ordinarily be able to take...
Talk with your tax advisor... and make sure you understand the full implications of a Roth conversion...
That’s another reason it often makes sense to think about doing conversions over several years... instead of all at once...
And here’s something to keep in the back of your mind...
The next time we see a big market pullback... when the value of your IRA drops significantly... that potentially could be an opportune time to think about a Roth conversion...
Why? Because you’ll be able to convert a bigger percentage of your IRA to the Roth... with the same tax consequences...
That’s the silver lining in the otherwise dark cloud of a bear market... take advantage of it when you can...
So... here’s how I would think about this...
Let’s say you’re in the golden window... that span of time between when you stop working... and when RMDs start at age 73...
Step one... is to figure out exactly how many years you have to work with... just how big is the window?
Step two... add up all your other sources of income for the year... are you taking Social Security yet... if not... when will you be? Add in your pension... and any other money you’ll be paying taxes on...
That has to go into your formula first... before you can decide how much Roth conversion you want to do...
Step three... decide on a conversion strategy... talk to your tax advisor... your financial advisor... see if the bracket-filling approach is the way to go... or some other way to spread out the tax hit by doing conversions in multiple years...
Step four... decide how you’ll pay the taxes... again... preferably from an account other than the IRA itself... make a plan...
And step five... schedule some time to work through this process next year... and every year until RMDs start...
You can do Roth conversions anytime you want... even after RMDs start... but the big advantages come during those years in the golden window...
So don’t waste them...
I’m Mike Brown... thanks for joining me today... let’s talk again soon...
Securities offered through Raymond James Financial Services, Inc., member FINRA/SIPC.
Investment advisory services are offered through Raymond James Financial Services Advisors, Inc. Brown Family Wealth Advisors is not a registered broker/dealer and is independent of Raymond James Financial Services.
Any opinions are those of Mike Brown and Brown Family Wealth Advisors and not necessarily those of Raymond James. This material is being provided for informational purposes only and is not a recommendation. There is no guarantee that these statements or opinions will prove to be correct. Investing involves risk, and you may incur a profit or a loss regardless of the strategy selected. Past performance is not indicative of future results. Prior to making an investment decision, please consult with your financial advisor about your individual situation.
Like Traditional IRAs, contribution limits apply to Roth IRAs. In addition, with a Roth IRA, your allowable contribution may be reduced or eliminated if your annual income exceeds certain limits. Contributions to a Roth IRA are never tax deductible, but if certain conditions are met, distributions will be completely income tax free.
IRA tax deductibility and contribution eligibility may be restricted if your income exceeds certain limits, please consult with a financial professional for more information. You should discuss any tax or legal matters with the appropriate professional.
