Roth IRA retirement taxes and conversions: what you need to know
Barron’s Retirement recently explored which accounts you should use first in retirement to minimize taxes. The conventional wisdom of always withdrawing taxable brokerage accounts or a bank account first is often flawed. It all depends on whether you are in a high or low tax bracket at the start of retirement.
Following this article, we’ve dug readers’ questions about Roth IRA conversions and other ways to lower your taxes in retirement:
How Does the Five Year Rule Affect Roth IRA Conversions?
Let us first take a step back. In a Roth conversion, you withdraw money from a tax-deferred account, pay income taxes, and put it in a non-taxable Roth IRA account.
If you are at least 59 and a half years old, you can still withdraw the converted money without paying taxes or penalties. However, you have to wait five years from January 1 of the year you first opened a Roth IRA before you can withdraw your income tax-free, according to Mike Piper, a certified public accountant at St. Louis.
Whether it is smart to withdraw money from a Roth so quickly is another matter. Because Roth accounts are so tax-efficient, they are often, but not always, the last accounts you should use in retirement.
“If you have a compelling reason in any given year to keep your income as low as possible, then spending from a Roth account may make sense,” Piper explains.
Do I need earned income to make a Roth conversion?
No. It is true that direct contributions to a Roth account must come from earned income. However, when you do a Roth conversion, the money comes from a tax deferred account and there is no income requirement.
“You can be retired and make a Roth conversion,” says economist Laurence Kotlikoff of Boston University, which sells retirement income smoothing software. “You can be unemployed and make a Roth conversion. It’s not really related to income.
Is there an income limit for Roth conversions?
No. There is a limit for direct Roth contributions, but not for conversions. “If you make $ 3 million a year, you can’t contribute to a Roth,” says Scott Bishop, CPA and financial advisor at Avidian Wealth Solutions in Houston. “But you can convert to Roth.”
I’m afraid the tax rates will go up? Is a Roth conversion a good idea?
Fear of rising taxes is one of the best reasons to make a Roth conversion. In general, it makes sense to make these conversions when your future tax rates are higher than your current rates. This could be because you will have higher taxable income in the future than you do now. But it could also be because tax rates are going up and you’re trying to lock in today’s lowest rates with a Roth conversion.
Greg Will, financial advisor and CPA in Frederick, Md., Advised clients to make Roth conversions for exactly this reason. “Tax rates are at an all-time low for most types of income,” he says. “Looking at the deficit, it seems pretty unlikely that tax rates will go down in the future, and it’s relatively likely that they will go up, at least for some people. “
How much should I care about triggering higher health insurance premiums in retirement?
A lot. These premium bumps can be expensive. Your monthly health insurance premium is based on your adjusted gross income modified two years earlier. A married couple could earn up to $ 176,000 in 2019 and each pay the minimum Medicare Part B premium of $ 148.50 per month in 2021. But if their income exceeds that level, premiums start to rise rapidly. (Here’s the Medicare rate chart.) A couple who earned $ 277,000 in 2019 would each pay a monthly premium of $ 386.10 this year. In addition, they will owe premiums for additional Medicare coverage or drug coverage.
One of the best ways to reduce future health insurance premiums is to make Roth conversions while in a low tax bracket early in your retirement before you start receiving Social Security.
Even if you don’t have enough income to trigger a higher health insurance premium as a couple, you can get one after a spouse dies and the survivor is taxed as a single person. A single filer pays a higher health insurance premium this year if they had income over $ 88,000 in 2019.
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