Many retirees overlook one of the best tax-planning windows in their financial lives: the years between retirement and required minimum distributions (RMDs). During this period, you may be able to convert traditional IRA assets to a Roth at relatively low tax rates before RMDs increase your taxable income. Here’s why timing matters.
A financial advisor can help you make the most of a low-tax window before RMDs begin. Connect with an advisor today!
The Low-Tax Window
If you retire before age 73, you may have a temporary period when your taxable income could drop significantly. Your paycheck is gone, RMDs haven’t started and your other income sources may be limited. That combination can create a rare opportunity to convert money from a traditional IRA to a Roth, while remaining in a lower tax bracket. Once RMDs begin, that window can close quickly.
The reason is simple: Lower taxable income can leave more room in the lower tax brackets for Roth conversions.
Here’s an example: Before RMDs begin, a married couple with little or no other taxable income may be able to convert $133,000 from a traditional IRA to a Roth. Their federal tax bill could be almost $12,000, or roughly 9% of the amount converted.
Let’s do the math: Assuming the 2026 standard deduction of $32,200 for married couples filing jointly, taxable income falls to about $100,800. 1 The first $24,800 is taxed at 10% ($2,480), and the remaining $76,000 is taxed at 12% ($9,120), for a total federal tax bill of $11,600.
Paying roughly $12,000 in taxes may sound expensive. But the alternative may be paying taxes on those same dollars later, when RMDs, Social Security and other retirement income leave less room in the lower tax brackets.
Every dollar converted before RMDs may be a dollar that can potentially grow tax-free and avoid future mandatory withdrawals. Leaving those same dollars in a traditional IRA means they will eventually be subject to RMDs and taxed as ordinary income.
The goal isn’t necessarily to avoid taxes altogether. It’s to pay them when the rate may be lower.
The Cost of Waiting
Once RMDs begin, the required withdrawal itself cannot be converted to a Roth. It must be taken first and added to your taxable income for the year.
That means part of your retirement income is no longer optional. Mandatory withdrawals can begin filling your lower tax brackets, leaving less room for future Roth conversions at favorable rates.
And RMDs are rarely the only income in play. Social Security benefits, pension payments, dividends and interest from taxable accounts can all stack on top of mandatory withdrawals. The result is often a higher taxable income than retirees anticipated.
In other words, a Roth conversion that fits comfortably in a lower tax bracket today may cost more once RMDs, Social Security and other retirement income start adding to your taxable income.
Large Roth conversions can also increase Medicare costs. If a conversion pushes your income above certain thresholds, you may have to pay higher Medicare Part B and Part D premiums through the Income-Related Monthly Adjustment Amount (IRMAA). This applies even before RMDs begin, since a large conversion in any year can trigger IRMAA surcharges two years later.
The Right Timing Depends on You
For retirees with large traditional IRA balances, the years before RMDs may offer the most favorable window to convert your money. Spreading conversions over several years could help avoid pushing income into higher brackets or triggering Medicare surcharges.
In some cases, waiting makes sense if taxable income is expected to fall even further in the years ahead. Additional factors like moving to a lower-tax state or needing access to converted funds within five years should be considered, as they may affect taxes and penalties.
A financial advisor can help you decide when to convert. Use SmartAsset’s advisor matching tool to get connected today!
Photo credit: ©iStock.com/Miljan Živković, ©iStock.com/Milan Markovic
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