Should Age 65+ Do Roth IRA Conversions?
Do seniors have a problem when it comes to Roth IRA conversions? In 2005 the congress removed a strict limit on conversion of traditional IRAs, SEP-IRAs and Simple IRAs into a Roth IRA.
Roth IRAs had entered the retirement planning landscape in 1997. The process at that time was to put a limited amount of already taxed dollars ($2,000) into an account that would grow and could be used tax free upon withdrawal in retirement.
The congress decided it needed more tax dollars after the dot.com bubble burst followed by 9/11. It offered a two-year (one time) payment of taxes to convert IRA funds into a Roth IRA. Millions jumped at the chance to never pay taxes on these accounts again. Beneficiaries would enjoy the same free tax distributions too.
Paying taxes on a conversion sets the taxpayer back maybe 15-25% depending on state and federal tax rules. Not doing a conversion lets an IRA continue to grow without taxation. Upon withdrawal from an IRA, distributions are fully taxable as ordinary income if the contributions were made pre-tax, as most are today.
Since the Roth IRA and later the Roth 401k gained popularity, and conversions continued to be touted in lots of financial planning articles in newspapers, magazines and financial blogs, there arose questions as to when and when not to do a Roth contribution or conversion.
There’s kind of a checklist of questions for financial planners to address when discussing Roth IRA conversions, especially for those aged 65 and above:
- When will you need the funds?
- What’s your guess at future tax rates versus current ones?
- Do you plan to move to a higher income tax state in retirement?
- What kind so tax rates do you foresee for your Roth IRA beneficiaries?
- Are you ok with increased Medicare Part B premiums since your income will increase because of a conversion?
- Do you want to reduce future Required Minimum Distributions and those taxes?
The answers to one or more of these questions can be the deciding factor to press ahead with conversion to entitle the next generation or reduce future taxes of other IRA distributions for current account holders.
The greatest drawback, in our experience, are the increased Medicare Plan B premiums resulting from large conversions and the resulting increase in income which affects the Medicare B premiums. This coupled with the need to use the funds before a serious amount of time has passed, calculates to a small degree of increased balances over IRA amounts paid out after income taxes.
There are several Roth conversion online calculators that can be found using Google including most major brokerage firms like Vanguard, Fidelity and Schwab.
In addition, we at MainStreet Financial Planning and other financial planners have software to create an individual customized report for our clients based on answers to our questions above.
If you’re age 65 or older and are a Medicare participant, then you should do detailed analysis before attempting a Roth IRA conversion. Will the government win, or will you and your beneficiaries win? That’s the big question.
Here’s a video I made answering this very question: Should a 65 year old do a Roth IRA conversion?