What You Should Know About ROTH IRA Conversions After Age 50 for Retirement

so by the time you're 50 you probably have a lot of money tied into IRAs and 401ks that you've never paid taxes on and you realize that hey tax bills are coming when that money has to come out so you may be considering a

Roth

conversion we're gonna dive in that into that today and answer our listeners question right after this so like I said if you're in your 50s and you have a lot of pre-tax dollars you may be considering doing a

Roth

conversion so

what

that means is just to

make sure we're on the same page as taking money that is in an IRA or 401k and converting it to a

Roth

IRA now the advantages of that are that hey any many growth from that point forward is going to be considered tax-free we all like tax-free and secondly you're gonna avoid those pesky

retirement

our required minimum distributions are MDS when you're 70 and a half which is the government making you take the money out so one thing we think about is doing

Roth

conversions

but one of

the negatives about it is let's say you take a hundred thousand dollars it's in an IRA or 401k and you move that to a

Roth

IRA

what

happens is you pay tax on the amount of money that you're moving to the

Roth

IRA so you pay your tax up front so let's say you're in the 28% bracket that would be $28,000 where are you gonna get the money to pay for that conversion to get the potential benefits that we talked about well one way to do it is to take the money from your existing IRA

in order to pay that and that's a question that David had who's a listener of the show and heard me on other shows oh by the way thank you Whitney Hansen for the money nerd shirt she is the host of the money nerds podcast you can check that out so

what

David asked was he said I'm 53 and I'm considering starting to do

conversions

into a

Roth

IRA so he's a little bit ahead of the game good job David but he says I would rather not pay for it with my after-tax assets can't I

just take my portion of my IRA and pay the taxes due on the conversion well yes you can do that David but here's the big gotcha because you're 59 or under 59 and a half that's considered a taxable distribution which means if you do that if you pay the tax due on a conversion from your IRA assets you're going to have that 10% penalty as an early withdraw so you it that changes the dynamics and it's probably not the wisest move to do and even without the 10% penalty in general

it's not in my opinion particularly wise to pay the tax from the actual IRA assets better to pay from the after-tax ask that's assuming you have them that way you keep more money in the

Roth

growing tax free without required minimum is minimum distributions for a long time so yeah David unfortunately if you're under fifty nine and a half you're gonna have to pay the penalty if you do that now David's second question is well well

what

if I'm 63 and I quit working and I

start to do some

Roth

conversions

which is something a lot of people consider about not a bad idea he wanted to

know

do I have to have earnings to be able to do that do I have to show some type of taxable income to be able to do a conversion and well the answer there David is no you don't you do have to have reportable income to make a contribution to a

Roth

but you don't have to have reportable income to do a distribution so you're good there now let's dive into this idea of

doing

Roth

conversions

later in life it gets a little bit more problematic because

what

ends up happening kit is so let me explain because I've done some analysis on this you

know

usually in our mid-50s or late 50s we're like I got all this money in 401ks and IRAs and I'm probably not going to touch it for a long time which means I'm gonna get the required minimum just abuse ends and they're gonna force me to start taking money out I think today it's about 3.6 percent and

it increases every year and I have a lot of clients that are taking required minimum distributions and they don't even need the money they don't be they have other assets and other income sources to provide a good problem to have but it's still a problem right one thought is in your 50s or 60s well

what

if I start converting to a

Roth

IRA one it'll be tax-free forever after that based on the rules and two I won't have to deal with required minimum distributions isn't

worth paying the tax up front to accomplish that so the way you analyze that decision is well a lot of times you go to a

Roth

conversion calculator I'll put one in a link below just to show you

what

a normal one looks like and you run the analysis to see whether it makes sense here's one of the problems with those that I found though because

what

you're gonna do is you gonna say okay I'm gonna convert let's say a hundred thousand dollars I'm gonna pay twenty eight

thousand dollars as an example out of my taxable investments how long based on a growth rate until I break even and make back my taxes and actually I'm ahead of the game that growth rate is a pretty key assumption in that equation so let's say you're being reasonable you say well let's assume it's a 7% growth rate okay I'm gonna be aggressive with it but little assumes 7% growth rate and you run the calculations and it will give you your breakeven on when this

Roth

conversion made sense well here's a big problem with these one-dimensional calculators is that when you input 7% as your growth assumption it's going to assume that you earn 7% every single year 7 percent 7 percent 7 percent do you ever get investment returns like that when you're investing in stocks and other things no even if they average 7% over a long period of time you rarely get even close to the averages now the way the we at real world works is it's lumpy you get twenty

percent you get fifteen percent you get thirteen percent or you get negative eight negative five three percent and that creates the average why am i bringing all this up because when you're evaluating doing a

Roth

conversion when you get those returns are drastically going to impact the utility of actually doing the conversion and making it worth your while I think those simple calculators drastically overestimate the value of actually doing them and the last time I now analyzed this a

little bit ago but it was a high net worth client when we factored in the fact that returns can be all over the place and did some Monte Carlo analysis it wasn't near a slam dunk as you originally thought it was and

what

we realized was it made sense if it was really multi-generational money which does a lot of times it could be because it has such a long period of time to work and that's a great way to transfer assets and stretch IRAs as for example so you got to be careful with those

calculators so how do we deal with this problem with all this money in pre-tax accounts once we're retired well one way is even if you don't need the money to live on once you retire you can start taking distributions from your IRA early pay the tax on it and manage

what

your taxable income is so you can minimize taxes and because you'll be in a lot lower tax bracket theoretically right when you retire so you can year by year make a determination of how much you're going to draw

from your IRA and put it into your taxable account to manage your tax rates try to minimize that tax impact over the over your life and if you don't need the money for sure you can take out a little bit each year and you got to do the calculation each year to manage your tax rate and rather than put it in an attack count convert it to the

Roth

and slowly build up your

Roth

over time I

know

this seems like it's a complicated subject and it just takes some intentional planning using a

multi-dimensional approach to get to the answer so you can make sure that you diversify your tax buckets so you can be as efficient as possible to well rock

retirement

right