Retirement savers who convert pre-tax retirement accounts, such as IRAs, to after-tax Roth IRAs after they turn 60 can continue to grow their funds tax-free and then take withdrawals in retirement without paying taxes. They avoid early withdrawal penalties and also don’t have to take required minimum distributions (RMDs), which can increase taxes after retirement. The downside is that they’ll have to foot a hefty tax bill on conversion and then wait five years to make tax-free withdrawals. A financial advisor can provide valuable information and guidance as you consider what to do with your IRA.
Roth IRA Conversion Basics
The difference between a Roth IRA and other types of IRAs is that the Roth account is funded with after-tax dollars. This means you pay taxes on funds before you contribute them to the Roth, and you can’t deduct the contributions from your taxable income. The upside is that the money in the Roth grows tax-free, and you can withdraw funds after you retire without paying taxes.
You can convert funds in pre-tax IRA accounts to a Roth IRA. This includes traditional IRAs, SEP IRAs, and Simple IRAs.
When you convert pre-tax money in a regular IRA to a Roth IRA, you must pay taxes at your current rate. This can result in a large tax bill for the year you do a Roth conversion. The conversion amount is treated as ordinary income, which may put you in a higher tax bracket.
A Roth IRA conversion can be worthwhile for a few reasons. First, it can overcome income caps that limit Roth conversions for higher-income taxpayers. Most taxpayers can contribute up to $6,000 to a Roth in 2021. But contribution limits are lower for higher-income taxpayers, and after a point, no Roth contributions are allowed at all.
For example, in 2021 for married taxpayers filing jointly, allowable Roth contributions begin to phase out at modified adjusted gross income (MAGI) levels of $198,000. Above $208,000 in MAGI, taxpayers cannot make Roth contributions.
However, there are no limits on conversions. A taxpayer with a pre-tax IRA can convert any amount of funds in a year to a Roth IRA.
Roth IRAs are also exempt from required minimum distributions (RMDs). These mandatory withdrawals from retirement accounts begin at age 72 and can create a tax burden on wealthy retirees. But Roth owners don’t have to make RMDs for as long as they live. This makes Roth IRAs especially useful for giving inheritances.
Keep in mind that where you plan to retire is another factor to consider when it comes to Roth IRA conversions. If you expect to relocate after retirement to a state with high income taxes, a conversion likely makes more sense than if you retire in a state with low or no state income tax.
Benefits of conversion after 60
Roth IRAs are popular with younger savers who expect to find themselves in higher taxes later in their working lives. However, they can also be useful for taxpayers over 60. One reason is that taxpayers in their 60s may be earning less than in their peak years, so the income tax on a Roth IRA conversion is less.
For those who have significant retirement assets and expect to receive retirement benefits in addition to Social Security, the RMDs of a regular IRA can also put them in a higher tax bracket after retirement. So converting to a Roth IRA now can, at the cost of paying some taxes today, lower your tax burden after retirement.
Disadvantages of converting after 60
Having to pay a big chunk of taxes today is the big disincentive to converting to a Roth. Another potential downside is that Roth accounts must be open for five years to avoid paying taxes on withdrawals. After age 59.5, withdrawals are not subject to a 10% early withdrawal penalty. But income taxes are still due even for people over 60.
There is a way around this. Roth IRA owners can avoid paying taxes on withdrawals if they wait five years after the conversion before withdrawing the converted funds. The same is true for any earnings on rollover funds, except that in addition to having to pay taxes on earnings before five years ago, Roth IRA owners also owe a 10% penalty on earnings they withdraw.
Roth IRA conversions are not recommended for all savers. For example, many retirees will have lower incomes than when they were working. For them, it’s probably best to use a regular IRA and pay taxes on withdrawals. Similarly, Roth IRA conversions may not make much sense if a taxpayer intends to leave assets in a regular IRA to charity.
Finally, the process of converting a regular IRA to a Roth IRA cannot be undone. A taxpayer who is unsure that post-retirement income taxes will be lower than they are today may want to think twice about a conversion.
For taxpayers who expect a higher tax rate after retirement, converting a regular IRA to a Roth IRA after age 60 can help reduce their overall tax burden over time. Roth IRA conversions allow earnings to grow tax-free and avoid the need to make required withdrawals that increase tax costs after retirement. However, Roth IRA conversions come with the cost of paying taxes on the converted funds now rather than later. Also, funds converted after age 60 must remain in the account for five years before they can be withdrawn tax-free.
Tips for retirement
Deciding whether or not to convert regular IRA assets to a Roth IRA requires careful evaluation of your financial and tax situation. That’s where a financial advisor can be invaluable. Finding a qualified financial advisor doesn’t have to be difficult. SmartAsset’s free tool matches you with up to three financial advisors in your area, and you can interview your advisors at no cost to decide who is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
Use our free retirement calculator to get an estimate of how you’re doing toward your retirement goals.
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