When To Do Roth Conversions (Married Before RMDs No Pension)

Roth conversions can make a huge difference in your retirement planning.

The rule of thumb is to convert when your tax brackets will be higher in the future, for instance:

Married people will have a higher tax bracket….

Low income with decent retirement accounts will have a higher tax bracket….

Between jobs, you’ll probably have a higher tax bracket…

After retirement Before RMDs…

Part I

After Retirement Before RMDs…

Let’s start with a simple example of a married couple just retired when the husband turned 60, and the wife 56, with an IRA balance of $500k.  They need $4,000 a month to cover all their needs. The Husband’s Primary Insurance Amount is $2900 and the wife’s is $1000.  They don’t plan on taking Social Security until the husband turns 67, his Full Retirement Age.  The wife will claim then too, but her spousal benefit will be reduced because she is not at FRA. 

Take Social Security at Full Retirement Age

For the next 7 years they will need to withdraw from their IRAs to net $48k a year to live on.  Once Social Security kicks in, they will need to withdraw less from their IRA.  Should they do Roth Conversions?

How does it all play out?

No Roth Conversions

Let’s start with a typical retirement scenario where they do NO Roth Conversions and instead just take distributions to cover their expenses and later the RMDs when they reach 70 years old. 

Graph 1

What you see here is that in the beginning of retirement, BEFORE Social Security they have around a 5% effective tax rate because they are taking distributions from their IRA to make ends meet. 

However once Social Security kicks in their distributions from IRAs drop and they actually have no taxes for about 4 years.  When the RMDs kick in though, those RMDs will force them into paying taxes again. In fact, the taxes will increase each year as the RMDs become larger and larger. 

At 90 when the husband dies, the “widows’ tax trap” comes into play and the wife’s taxes have increased by 34% even though her income has dropped by 25%. 

Graph 2

Roth Conversions At Full Retirement Age

They don’t like that scenario, so let’s say they start doing Roth conversions when the husband turns 67, when they start taking Social Security. 

Graph 3

Graph 4 – Taxes

Notice, unlike in Graph 2 when the wife’s dropped by 25% and the taxes went up by 33%, in this case, because of the Roth conversions the widow owes ZERO tax!

With the Roth conversions they’ll pay a total of $87,000 in Federal taxes.

Without the Roth conversions they’ll pay $100,000 MORE for a total of $187,000!

Now let’s take a look at total net worth, remember, one of the drawbacks about doing Roth conversions is you have to pay taxes when you convert the money. The taxes are money that inherently can’t be used to grow one’s portfolio. 

Graph 5

Ending Net Worth with No Roth

What Graph 5 shows us is that at the death of the surviving spouse they are leaving a liqui net worth of $1.7 million.  Unfortunately, though, a good amount of that, $529,484 to be exact, is left in an IRA which will be taxed to the heirs at Ordinary Income rates.

Now, because their Mandatory Distributions were higher than the amount they needed to live on, they did leave $1.17 million in a non-IRA account which will transfer to the heirs tax free.  However, they did have to pay tax on that money, via capital gains dividends and interest, while they were alive, which increased their total taxes. 

If we look at Graph 6 below, we see what the net worth looks like when they were doing Roth conversions. It’s only about $70k less than it was with no conversions BUT because that money is ALL in a Roth, it’s ALL tax free, thus increasing the net amount the heirs will receive. 

Graph 6

Net worth after doing Roth Conversions

Roth Conversions At 60

Let’s assume this couple loves the idea of not paying taxes in the future and want to begin Roth conversions right away when they first retire.  How does this shake out?

In this case they pay $55,600 in total tax over the first few years of retirement and then paid no more Federal taxes again, ever, after the husband turned 67. That is $130k LESS in taxes than not doing any Roth conversions and $30k less in taxes than waiting until 67 to do Roth conversions.

In fact, as Graph 7 below shows when the husband reaches 67, all of their IRA money is in Roth’s at this point meaning there will be no Mandatory Distributions and their ENTIRE Social Security will be tax free too. 

Graph 7

Now, one may wonder how their net worth fares given they were front-loading these Roth conversions. 

Graph 8 shows they leave a BIGGER legacy than they did when they waited until 67 to do the Roth conversions. Not much, mind you, but they do leave $9k more, and again it’s tax free. 

Graph 8 

Net Worth

So, in this couple’s case, not only do they pay significantly LESS in taxes by doing the Roth Conversions vs. not doing Roth Conversions but by doing Roth Conversions when they first retire they also leave a higher asset base to their heirs. 

Seems to me this is a slam dunk.

For Part II

One thing we haven’t discussed is what happens if they have a secondary source fo income, say a pension.  So, let’s throw a $30k pension in the mix and see how it looks. 

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