Savvy Senior: Is a Roth conversion right for you?

Dear Savvy Senior,

I’m 66 and recently retired, and I’ve been reading about converting a traditional IRA to a Roth IRA. I’m a little confused about how it works and whether it’s worth doing at my age. What should I know?

--Curious Retiree

Dear Curious,

A Roth conversion can be a useful tax-planning tool for some retirees, especially between retirement and required minimum distributions. But it isn’t for everyone. The key is figuring out whether paying taxes now could benefit you by providing more tax-free income and flexibility later.

How it works
A Roth conversion means moving money from a traditional IRA into a Roth IRA. You can also convert money from certain workplace retirement plans, such as a 401(k).

With a traditional IRA, you generally get a tax break when you put money in, but pay taxes when you take it out. With a Roth, you don’t get that upfront tax break, but qualified withdrawals are tax free.

When you convert traditional IRA money, the amount that hasn’t already been taxed is generally added to your taxable income for that year. So, a $50,000 conversion could add $50,000 to your taxable income and potentially push you into a higher tax bracket.

Why consider it?
One big advantage is that Roth IRAs don’t require RMDs during your lifetime. Traditional IRAs generally require RMDs beginning at 73, although people born in 1960 or later generally don’t have to start until 75.

That creates a useful planning window. If your income drops after retirement, you may be able to convert some traditional IRA money while you’re in a lower tax bracket.

A Roth can also provide more flexibility because qualified withdrawals aren’t taxable. Qualified withdrawals from an inherited Roth IRA generally aren’t subject to income tax, although beneficiaries still have distribution rules to follow.

If you’re on Medicare, there’s another wrinkle: A large conversion can increase your income enough to trigger higher Part B and Part D premiums. Medicare generally uses your tax return from two years earlier to determine these surcharges.

How to convert
If you have a Roth IRA, contact your brokerage or financial institution and request a conversion. You choose how much to move, and the money can generally be transferred directly from your traditional IRA to your Roth.

If possible, pay the resulting tax bill with money outside your retirement account. That allows the full amount you convert to go into the Roth.

Rules to know
There are no income limits or annual dollar limits on Roth conversions. But the converted amount generally counts as taxable income for the year you make the conversion, and you generally can’t undo it.

There are also two five-year rules. One applies to when Roth earnings can be withdrawn tax free. The other applies separately to each conversion and can result in a 10 percent penalty if converted money is withdrawn too soon. Since you’re already over 59½, that penalty generally isn’t a concern.

Once RMDs are required, you generally can’t convert that year’s required distribution to a Roth.

Is it right for you?
There’s no magic age when a Roth conversion makes sense. It comes down to your numbers.

For a recent retiree, the years before RMDs begin may be especially useful. Your income may be lower than it was while working, giving you an opportunity to convert some money without moving into a much higher tax bracket.

Before converting, consider your current and future tax brackets, other income, Medicare premiums and future RMDs.

A tax professional can help you run the numbers. And remember, you don’t have to convert everything. Converting a little at a time can make the tax bill easier to manage.

Send your questions or comments to: Savvy Senior, P.O. Box 5443, Norman, OK 73070, email questions@savvysenior.org, or visit SavvySenior.org.