The Sweet Spot for Roth IRA Conversions
My favorite delicacy is a cream filled long john. Pastry at the beginning, creamy white middle, and pastry at the end. The best part is the creamy middle. Delicious sugary white goodness….. We’ve been writing about Roth IRA’s and when to convert from a traditional IRA. In our view, the best time for the conversion is often, well, in the middle.
And by middle we mean after you finish your working years and prior to when you have to take “required minimum distributions” from your traditional IRA.
This can be a little confusing, so let me first explain a term. The term RMD stands for “Required Minimum Distribution”. Once you reach a certain age, the IRS requires you to move a certain percentage from your traditional IRA to another account, and incur the tax for that amount of money. They do this to ensure you eventually pay taxes on the money you’ve stashed in your traditional IRA. The current age when you have to take RMD’s is age 73 (in 2023, this number changes to 75). In other words, the year you turn 73, you have to take an RMD. In your 73rd year, you would need to take ~3.7% from your traditional IRA.
So, back to the concept. The bottom line is that a conversion from a traditional to a Roth is best made between when you finish working and when you start taking your RMD. Why? This is the time in your life when your income is lowest. This puts you into a lower tax bracket, reducing the tax burden caused by the conversion. If you do this, you will then have money in a Roth IRA that is never taxed again. You won’t have to incur taxes and neither will your heirs if you choose to pass the money along to them. The graphic below shows the sweet spot, and I then explain it below:
You can see in the graphic that this individual earns between $250,000 and $300,000 during their working years, retiring at age 70. During those years, the individual’s tax bracket is 24% (assume married filing jointly). This individual wouldn’t want to convert traditional IRA funds to Roth IRA because the income would be pushed into the 32% tax bracket. And then you can see after the RMD’s start at age 75, the person’s income goes up again, once again pushing the income into the 24% tax bracket.
That middle area, with the green color, is the best time for the conversion. The person’s income is quite low. The person can “fill up” the 24% tax bracket by converting traditional IRA to Roth IRA money. They can convert more than $300,000 each year for 5 years from traditional to Roth, and stay in the 24% tax bracket.
If you like the creamy middle of a long john and want to plan for Roth IRA conversions during that time, feel free to give me a call.
Jared
Planning Pays Dividends
Ben Franklin wrote the quote about death and taxes in his 1789 letter to Jean-Baptiste Le Roy.
City of Cincinnati individual tax return: https://www.cincinnati-oh.gov/finance/income-taxes/2023-tax-forms111/2023-individual-tax-return/
City of Madeira tax instructions: https://www.madeiracity.com/government/departments/tax/qualifying_wages.php
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