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If you’re 60 years old with $1.2 million saved for retirement in a traditional IRA, you may be starting to think about required minimum distributions (RMDs) and the hefty annual tax bill they can create once you turn 73. Converting a portion of your IRA to a Roth IRA each year can help you reduce or avoid RMDs and take control of your tax bill – but also comes at a cost. Discuss your Roth IRA conversion questions with a financial advisor to determine if this strategy aligns with your broader financial plan.

RMD Rules: The Basics

Once you turn 73, the IRS requires that you start taking annual distributions called required minimum distributions (RMDs) from traditional IRAs, 401(k)s and similar tax-deferred accounts. RMDs are calculated by dividing your account balance by your life expectancy factor, a value that is set by the IRS based on your age.

RMD withdrawals are treated as ordinary income. With a large IRA balance, the size of the mandatory RMDs could easily push someone into a higher tax bracket and result in a higher tax bill. Remember, a financial advisor can be a valuable resource when it comes to planning for RMDs.

Roth Conversions

Roth IRAs, unlike traditional IRAs and 401(k)s, aren’t subject to RMD rules. So by converting your IRA to a Roth, you could avoid having to pay extra income taxes from mandatory IRA withdrawals in retirement. The catch is that you have to pay income taxes on the amount you convert at your ordinary income rate when you convert it. This can lead to a massive tax bill if you were to convert a $1.2 million IRA to a Roth all at once.

Instead, gradually converting your traditional IRA to a Roth IRA allows you to control when you pay taxes. Rather than unspecified mandatory RMD withdrawals, you choose when to take taxable Roth conversions. Roth withdrawals in retirement are then tax-free, provided you wait five years to withdraw those assets.

Keep in mind that the five-year period applies to each conversion. If you were to convert a portion of your IRA in 2024, 2025 and 2026, you’d have to wait until 2029, 2030 and 2031, respectively, to withdraw each group of funds tax-free.

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If you need additional help navigating the rules surrounding Roth conversions, use this tool to match with a financial advisor.

A Roth Conversion Example

Assuming your investments grow at 5% each year for 13 years, your $1.2 million IRA could be worth around $2.3 million by the time you reach age 73. By that time, your first RMD would be approximately $87,000 based on the IRS life expectancy factor. Assuming you’re collecting $80,000 annually in taxable income from pensions and Social Security, adding an extra $87,000 would push you from the 22% bracket into the 24% bracket. (This assumes that the current tax brackets remain in place after 2025 when key provisions of the Tax Cut and Jobs Act sunset.)

But with 13 years of $120,000 Roth conversions already completed, the IRA balance requiring RMDs could be reduced to around $42,000 by age 73. Your first RMD would be just under $1,600. This would likely not push you into a higher bracket and save you thousands in annual taxes during retirement compared to taking the full $87,000 distribution without any prior Roth conversions.

The key is to not convert your entire IRA to a Roth immediately, but rather take an incremental approach. By limiting Roth conversions to a certain amount, you can control and potentially reduce your tax liability. Spreading conversions over time allows taxpayers to fill up their current bracket without exceeding it. By staying in lower brackets, more money is shielded from future taxes than paying the IRS immediately at today’s rates.

But you don’t have to do it all alone. A financial advisor can help you plan out your Roth conversion strategy and manage your taxes in retirement.

Roth Conversion Limitations

No matter how you do it, Roth conversions trigger taxes. Without sufficient non-retirement savings or other sources of income, investors may struggle to pay conversion taxes or be forced to sell investments at a loss. Optimal timing and tax planning are also challenging. Tax rates and laws can change frequently, making it hard to predict brackets decades in advance. Income fluctuations from bonuses, dividends or retirement plan withdrawals also complicate projections.

Converting too little defeats the purpose of avoiding higher future RMD taxes. But converting too much could push you into higher brackets now or reduce your flexibility if tax rates decline. Balancing present and future tax minimization is tricky with many uncertainties at play over long time horizons.

Additional factors may also come into play. Deductions that reduce taxable income, state taxes, fluctuating investment returns and income from other sources such as part-time work are all potentially important variables that need to be considered to craft the optimal strategy for Roth conversion. If you need additional help navigating these factors, consider working with a financial advisor.

Bottom Line

Roth IRA conversions let investors take control of the timing of their tax liability. By paying taxes now at known rates through incremental conversions, overall lifetime taxes can be reduced compared to unpredictable mandatory RMD withdrawals decades into the future. But Roth conversions come at a cost today, require non-retirement funds to pay taxes, and involve considerable analysis and some guesswork to optimize.

Retirement Planning Tips

• A financial advisor can help develop Roth IRA conversion strategies. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.

• Knowing how much money you’ll need to retire and whether you’re on track to hit that target is vital when you’re planning for your golden years. SmartAsset’s retirement calculator can help you estimate how much you may have in savings when the time comes for you to retire.

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