On average, Americans are living longer than ever before. This reality has complicated the planning and saving stage of retirement as we struggle to secure enough income to cover our needs for the duration of our lifetime. One increasingly critical tool of financial planners for retirees is the use of Roth IRA conversions. A Roth conversion refers to taking all or part of the balance of a pre-tax traditional IRA and moving it into a Roth (after-tax) IRA.
The primary benefit of a Roth IRA over a traditional IRA is to enjoy tax-free withdrawals. With a traditional IRA, as well as with 401(k)s, 403(b)s, simple IRAs, and/or any other pre-tax qualified plan, taxes must be paid on any distributions from your investment and are treated as ordinary income. With a Roth IRA, within certain requirements, all withdrawals are tax-free—allowing for a more reliable and robust income stream during retirement.
A second benefit of these untaxed distribution withdrawals is that the taxation on income derived from pre-tax qualified plan distributions must be included in the calculation of your Medicare premium. This calculation is how the government calculates your monthly premium for healthcare in retirement. What does this mean? When you sign up for social security, by law, the retiree also has to sign up for Medicare. Medicare premiums are calculated based on taxable income and are automatically taken out of your social security benefit check. So, if you are scheduled to receive, for example, $2,200/month from social security, you must pay taxes on that gross amount, and that taxable income will count in the Medicare Modified Adjusted Gross Income Calculation. Roth conversions are an excellent way to re-characterize pretax savings, allowing you to dictate years in which to pay taxes on that money, rather than at distribution. This allows for an individual to offset Roth conversion taxes with losses incurred through investment or other tax advantaged situations.
A third main benefit of a Roth conversion is that traditional IRAs demand that you take a required minimum distribution (RMD) every year after the age of 70.5, regardless of whether you need/want the money or not. This eliminates tax-free growth on the money you have in the account and works against a long-term income source to last throughout retirement. Roth IRAs have no RMDs, creating a stable income source that can grow longer and be utilized as needed.
Roth IRA conversions provide: the ability to control your taxable income throughout retirement, provide an opportunity to control an individual’s Medicare premium costs, and allow the freedom to choose when and how much money to distribute—making them one of the most versatile and useful income vehicles for retirees.
Please contact the Sapers & Wallack financial planning department and we will be happy to run the analysis for you to find out if the Roth conversion is right for you.
Want to learn more? Listen to our podcast!