Question: I'm retiring later this year at 67 with $2.6 million, most of which is in a traditional IRA. I'm worried about RMDs and taxes. What should I do?
Answer: As of 2022, the last year for which there's data available, the average 67-year-old retiree had about $609,000 in retirement savings, according to the Federal Reserve. Moreover, retirement savers in their 60s only averaged $257,000 in their IRAs. So if you're retiring later this year at age 67 with a $2.6 million IRA, you're clearly ahead of the game.
If that money is in a traditional IRA, though, you'll have to start taking required minimum distributions (RMDs) once you turn 73. And while RMDs aren't guaranteed to be a problem, they could be if you find yourself in a situation where you don't actually need the money.
Why does the IRS impose RMDs on traditional retirement plans? As Mark Steber, chief tax officer at Jackson Hewitt Tax Services, explains, "They want you to enjoy some of that money, but more importantly, they want the taxes from that money."
If you don't like the idea of facing RMDs in the future, there may be a way to largely get out of them. But it's important to proceed with caution.
Consider a Roth conversion carefully
If you don't want to deal with RMDs in retirement, the Roth conversion is a legitimate strategy, Steber says. And the coming years may be an optimal time to do that conversion.
"If you're in that retirement income valley, and your income and tax rate go down substantially, that gives you the opportunity to take some of that retirement money and dump it into a Roth," he explains.
But, Steber says, you have to know what your total tax bracket is before rushing into Roth conversions. At age 67, you may be receiving Social Security or working a side hustle, both of which could affect your tax bracket. So it's important to look at the big picture.
Robin Lovely, founder at The Women's Advisory Group, agrees that a Roth conversion could be a smart move in this situation. But she cautions against rushing into a major conversion at once.
"A series of smaller strategic conversions over the next few years could make more sense," she says. "The idea is to fill up your current tax bracket without spilling into the next one. That way, you reduce the size of your future RMDs and give yourself some tax-free income later on."
Of course, one drawback of doing a Roth conversion, whether in one fell swoop or over several years, is the potential to get hit with Medicare surcharges known as income-related monthly adjustment amounts, or IRMAAs. Because Roth conversions count as income, they could propel you into the IRMAA category in two years' time.
But Cody Garrett, owner and financial planner at Measure Twice Financial, says, "Some retirees worry about IRMAA when planning Roth conversions, but I don't let it rule the decision making. At any bracket, the IRMAA does not exceed 3% of household income based on modified adjusted gross income two years prior. It may be worth paying higher Medicare premiums for a few years to avoid higher tax rates and IRMAA for decades."
Don't put all of your money into a Roth
Timing Roth conversions strategically could let you off the hook from RMDs and associated taxes later in life while minimizing the tax blow in the near term. But Steber cautions not to move all of your money into a Roth account.
"It is truly a best practice to have multiple types of retirement buckets," says Steber. That means maintaining a mix of traditional and Roth accounts.
"When you have multiple buckets, you have a lot more latitude for planning," he explains.
Steber points out that we don't know what tax breaks could come down the pike. There could be future tariff rebates or tax credits you can only qualify for if you have taxable income to report. As such, Steber says diversifying your retirement income is "a smart play."
Don't assume the worst if you're stuck with RMDs
A lot of people view RMDs as a negative in the context of retirement. But Garrett says, "With $2.6 million in a traditional IRA, RMDs may be meaningful, but they're not automatically catastrophic."
One thing to realize about RMDs is that they could serve as a green light to treat yourself to luxuries or a travel splurge you wouldn't otherwise spend money on. Plus, if you're charity-oriented, RMDs give you an opportunity to make qualified charitable distributions (QCDs) and support organizations that mean a lot to you.
There's nothing wrong with planning for RMDs and taking steps to reduce them in the future if you have a lot of money in a traditional retirement account, says Garrett. At the same time, he says, "Please don't make Roth conversion decisions based on fear. There's often a temptation with large traditional retirement account balances to rush into aggressive Roth conversions. Slow down, take a breath, and unpack the comprehensive planning situation."
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