Experts in finance are urging older adults in the US to think about a calculated approach with their 401(k) plans that may lead to significant tax savings during retirement. This tactic consists of converting traditional IRA or 401(k) plans into Roth IRAs. Roth conversions entail moving money from tax-deferred retirement accounts into Roth IRAs, which are contributed with after-tax funds.
As a result, account holders will need to settle taxes on the amount converted at the conversion time. Nevertheless, subsequent withdrawals from Roth IRAs remain tax-exempt, and there are no Required Minimum Distributions (RMDs) imposed while the account owner is living. Brent Ehmke, a 72-year-old retired aerospace leader from Plano, Texas, acknowledged that he would encounter a hefty tax obligation due to over $100,000 in annual RMDs from his tax-deferred retirement fund, along with other income from Social Security, pensions, and investments.
“I’m questioning myself, ‘Goodness! Have I made a blunder? Did I wait too long?’” he expressed. To sidestep increasing taxes and various financial complications, experts recommend executing calculated Roth conversions gradually.
This methodology assists retirees in avoiding higher tax tiers and aids in better managing their overall tax burdens.
Cost savings via Roth conversions
Moreover, keeping income at lower levels may help in evading hikes in Medicare premiums and the 3.8% net investment income tax.
“When executing a Roth conversion, you might find yourself placed in a higher tax bracket for that year or experience a rise in your Medicare premium,” various sources indicate. To lessen this impact, gradual, small conversions spread over several years are advised. Generally, Roth IRA conversions are financially advantageous if the tax rate during conversion is lower than the expected rate during future withdrawals.
In addition, Roth conversions benefit those planning to pass on tax-free funds to their heirs. High-income individuals who do not need their RMDs or those with lower expenses during retirement make for perfect candidates for this approach. It’s also advantageous for addressing tax-deductible long-term care costs, which could be more favorably handled from a traditional IRA rather than a Roth IRA.
To fully benefit from this option, seniors should be aware of the five-year rule associated with Roth IRAs: earnings are tax-free only after the account has been active for at least five years. As such, Roth conversions are particularly suited for individuals not needing immediate access to the funds. While this tactic might appear counterproductive at first, Roth IRA conversions present considerable tax advantages and financial versatility for many retirees.
Nonetheless, it remains crucial to thoroughly evaluate one’s financial landscape and seek advice from a financial professional before proceeding, as Roth conversions are irreversible and should be meticulously planned.
