Converting retirement savings held in a 401(k) to a Roth account can help you reduce or even avoid mandatory withdrawals while giving your more tax planning flexibility. Roth conversions can be particularly helpful if you expect to be in a higher tax bracket in retirement.
Talk over your retirement plans with a financial advisor any time you’re considering a significant financial move. Find a financial advisor today.
However, Roth conversions come with high upfront costs tied to the income tax that’s owed on converted balances. With $1.4 million in savings, that tax bill could be hefty. Then again, gradually converting $120,000 each year may not be enough to completely eliminate the required minimum distributions (RMDs) you may be hoping to avoid.
Roth Conversion Considerations
Many retirement planners help clients carry out Roth conversions, and one big reason is the added tax planning flexibility they provide. Because Roth IRAs are not subject to RMDs, transferring retirement savings from a 401(k) or similar tax-deferred account into a Roth IRA means you won’t have to take taxable mandatory withdrawals starting age 73 (or 75 for people born in 1960 or later). Plus, qualified withdrawals from a Roth IRA are not taxable.
The downside is that converted funds must be reported as taxable income on your next return, which likely means a larger tax bill for the year in which you do the conversion. This can still make sense if you expect to be in a higher tax bracket after retiring. If you anticipate being in a lower tax bracket in retirement, however, conversions may actually result in you paying more in cumulative taxes.
A financial advisor can help you explore and navigate the potential implications of doing a Roth conversion. But if you need help finding a financial advisor, SmartAsset’s free tool can match you with up to three fiduciary advisors who serve your area.
Roth Conversion Strategies
There are two main ways to go about a Roth conversion. You can convert all the funds in a single transaction, which can lead to a large one-time tax bill, or spread it out over several years.
If you convert $1.4 million all at once it would put you in the top marginal tax bracket. For 2024, that rate is 37% and would result in a one-time federal income tax bill of nearly $471,000 on the converted funds.
The alternative is to convert $120,000 each year until you reach RMD age. Someone who’s 61 in 2024 wouldn’t be required to take RMDs until they turn 75, giving them 14 years’ worth of conversions. If you converted $120,000 each year, your annual tax bill would depend on your other taxable income. However, it would most likely be considerably less than doing a lump sum conversion.
For instance, if you consistently have $100,000 in other taxable income, adding $120,000 in converted funds each year would put you in the 32% marginal tax bracket. This would produce an annual tax bill of approximately $42,000.
But if you need additional help planning for the taxes associated with Roth conversions, consider speaking with a financial advisor.
Other Conversion Concerns
Also, keep in mind that the five-year rule for Roth conversions requires you to wait five years before withdrawing the converted funds. Withdraw the money early and you’ll face a 10% early withdrawal penalty. This five-year waiting period starts on January 1 of the year in which the conversion is made. However, if you’re already in your 60s, the rule won’t apply to you, since it only applies to people who are under age 59 ½.
Also consider that withdrawing $120,000 each year over a 14-year probably won’t completely empty the account, since the funds that are in the 401(k) would likely continue to earn interest. This means you may still have to take RMDs and pay taxes on the withdrawals after age 75, although they will be smaller than if you had not done the conversion.
Finally, Roth conversions can’t be undone. For this reason, it makes sense to carefully review your options before proceeding and to consider converting only part of your 401(k). Fortunately, that’s where a financial advisor can potentially help.
Bottom Line
Gradually converting a 401(k) worth $1.4 million into a Roth IRA using annual conversions of $120,000 would reduce your eventual RMDs, but may not eliminate them altogether. This gradual approach can still make sense, especially if you expect to be in a higher tax bracket in retirement. However, a Roth conversion requires you to pay income tax on the converted balance in the year of the conversion, which will likely add to your tax burden during these years.
Retirement Income Planning Tips
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If you’re like most retirees, Social Security benefits will be a primary source of income after you stop working. Use SmartAsset’s Social Security calculator to estimate how much you’ll receive in government payments so you can integrate the estimate into a comprehensive income plan.
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A financial advisor can help you establish and manage your income streams in retirement. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three financial advisors in your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
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The post I’m 61 With $1.4 Million in My 401(k). Should I Convert $120k Per Year to Avoid RMDs? appeared first on SmartReads by SmartAsset.
