'I don't expect my marginal tax rate to be materially different in the future'
"My spouse is 73 and is already taking required minimum distributions (RMDs)." (Photo subjects are models.)
Dear Quentin,
I'm 63, retired, and living off my savings until Medicare, Social Security and a small pension begin at 65. I plan to claim Social Security before 67.
My financial adviser is recommending Roth conversions, but I'm a retired CPA, and based on my projections, I don't expect my marginal tax rate to be materially different in the future. My spouse is 73 and is already taking required minimum distributions (RMDs).
Our liquid assets consist of roughly: $1.2 million in my 401(k) and $500,000 in taxable and Roth accounts.
My spouse is financially secure independent of my retirement assets.
So I'm wondering whether I'm missing something. If my marginal tax rate is likely to be about the same whether I convert now or pay the tax later, is there a meaningful advantage to doing Roth conversions in my situation?
I understand the usual arguments - reducing future RMDs, avoiding higher future tax brackets, and creating tax-free assets for heirs - but I'm not sure they carry much weight in my particular case.
Am I overlooking an important factor, or am I simply one of those retirees for whom Roth conversions don't offer a significant benefit?
Cautious About Conversion
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CPA, don't advise thyself.
Dear Cautious,
CPA, don't advise thyself.
You are 63; your RMDs won't kick in until 75; and you have not yet started Social Security - so you are in a potentially valuable window for Roth conversions. If you start Social Security at 67 or 70 and take $48,000 a year - roughly 4% of your $1.2 million 401(k) - that would be taxable income and could cause more of your Social Security benefits to be taxed. So it actually makes sense to consider making Roth conversions while your taxable income is relatively low.
Your provisional income, as defined by the Internal Revenue Service, includes half of your Social Security benefits plus other taxable income and tax-exempt interest. Once certain thresholds are reached, up to 85% of your Social Security benefits can be included in taxable income. Your 401(k) withdrawals increase your taxable income, which can also increase the portion of your Social Security subject to tax.
You write that you are living off your savings until Medicare, Social Security and your pension all kick in at 65. So you have two years to make those Roth conversions count. Ideally, it's something you should have considered when you first retired. The reason: You are now in that classic window for conversions. The key question is whether the tax you pay on those conversions now is lower than the marginal tax cost you are likely to face later.
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Federal tax bracket
Hire a certified financial planner (CFP) or enrolled agent $(EA)$ specializing in tax and retirement-income planning. They can calculate a scenario in which you take Roth conversions and fill a federal tax bracket, and compare that with a scenario in which you don't take Roth conversions. This should take into account your wife's RMDs, Social Security, pension and other income, your future RMDs, and Medicare premiums.
You have a bit of planning to do before deciding to ignore this Roth-conversion window. There's more at stake than just a higher tax bracket. For a married couple filing jointly, your Social Security benefits can become taxable when half of your Social Security benefits, plus other taxable income and tax-exempt interest, exceeds $32,000. At higher income levels, up to 85% of your benefits can be included in taxable income.
You should also have them estimate your Medicare IRMAA. Medicare generally uses your income from two years earlier to determine whether you pay higher Part B and Part D premiums. Therefore, a Roth conversion can affect the Medicare premiums you end up paying, although the impact will depend on your income in any given year. You could also be subject to the 3.8% net investment income tax on investment earnings from your brokerage account.
You have two years before your best-case-scenario conversion window closes.
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-Quentin Fottrell
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