Converting funds from a traditional 401(k) to a Roth IRA can give you tax-free retirement income, and there’s no rule against converting at any age. However, transitioning when you’re nearing retirement age or transitioning involves some additional considerations. For one thing, you may have to let converted money age for five years before you can withdraw without penalty. Other issues include the possibility of paying a large current income tax bill, and possible effects on the tax on Social Security benefits and the availability of tax credits, as well as charitable bequests and other estate planning issues. Before we get into the specifics of this example, let’s look at some general rules.
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The tax laws allow you to. Transfer funds from a traditional 401(k) to a Roth IRA As long as you pay tax on any transferred funds at your current rate. This means that if you’re rolling over a large 401(k), you could get a big tax bill. Some savers choose to make the switch anyway because Roth accounts allow for tax-free withdrawals in retirement and are also not subject to: Required Minimum Distribution (RMD) Rules. Once in your Roth, you can leave the funds there indefinitely, growing tax-free.
There are also strategies for managing and minimizing the tax bill for a Roth conversion. The key approach is to spread the changes over several years so that your current income doesn’t increase too much and you get into the top tier. Income tax bracket. However, there are many moving parts to making this decision, so each case is evaluated differently.
You may or may not retire at age 67. In six years, when you turn 73, you’ll have to start taking RMDs. If you withdraw the $1.2 million in your IRA, it will be $1.8 million over six years at 7 percent growth. Your first year RMD will be approximately $68,000.
Assuming your taxable family income from Social Security and other sources is still up to $60,000, this extra income in retirement moves you from the 12% federal income tax bracket to the 22% bracket by 2023 for marginal income taxpayers filing jointly. .
If you don’t need the money from RMDs and want to avoid paying extra taxes in retirement, you can convert your 401(k) to a Roth account. Then funds in the Roth are not subject to RMDs and any voluntary withdrawals are tax-free. To get these benefits, however, you must now pay taxes on any money you convert.
If you roll over the entire $1.2 million 401(k) immediately, that would increase your taxable income to about $1.26 million, putting you in the nice 37% bracket and bringing your current tax bill to $385,865. A better way may be to rollover your 401(k) over time.
For example, if you transfer $130,000 each year, this would increase your current taxable income to $190,000, below the threshold to move from the 24% marginal tax bracket to the 32% tax bracket. They pay about $26,000 a year. After six years, you convert $780,000 to a Roth fund that is not subject to RMDs and is tax-free.
Let’s say your 401(k) balance, including annual growth, drops to about $898,000. With that amount in your 401(k), your RMDs would be $33,886. That amount of RMD income added to taxable income from other sources can allow you to stay in the 12% bracket, assuming future tax brackets are adjusted annually as before.
There are several other important considerations to consider before starting a Roth conversion. One of them should be converted currencies Stay in the Roth for five years Before leaving or you will be fined 10%. This means that you will need other sources of income to fund your retirement until the Roth fund is ready to withdraw penalty-free.
You also need to consider how much of an impact it will have on your current income by switching from a 401(k) to a Roth. Your social security taxes Benefits. Medicare premium And Tax credits Also, your taxable income may be affected during the Roth conversion process.
Estate planning It can raise other issues. For example, some savers who plan to leave money to charity prefer to leave all or part of their money in a 401(k) rather than converting to a Roth during their lifetime because charities are not subject to bequest taxes. On the other hand, if you want to leave an inheritance to beneficiaries like children, you can choose to do a Roth conversion, because they can. When you die, take control of the account without going through probate.
Again, a financial advisor can help you navigate legal differences regarding conversions, retirement and estate planning. Contact a trusted advisor today.
Converting a $1.2-million 401(k) to a Roth account is a financial move worth considering at age 67. You avoid mandatory withdrawals from mutual funds, and can withdraw voluntarily without incurring any tax liability. Making a single transaction may result in a higher tax bill than you’d like to pay, but gradual conversion over time will reduce your overall tax bill to more manageable payments.
Making the right decision about converting 401(k) funds to a Roth account requires modeling the possible outcomes of various scenarios. A financial advisor can help you with those models. Finding a financial advisor doesn’t have to be difficult. SmartAsset’s free tool It matches you with up to three financial advisors in your area, and you can interview your advisor at no cost to decide which one is right for you. If you’re ready to find an advisor to help you achieve your financial goals, Start now.
Predict future mandatory payments from your IRA or other pre-tax retirement savings account using SmartAsset The required minimum distribution Calculator.
Keep an emergency fund handy in case you run into unexpected expenses. An emergency fund should be liquid – in an account that is not exposed to high volatility in the stock market. The trade-off is because the value of liquid cash can be eroded by inflation. But a high-interest account allows you to earn compound interest. Compare savings accounts from these banks.
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