Converting an IRA to a Roth IRA is a popular approach to avoiding mandatory required minimum distributions (RMDs) — and the associated taxes — in your 70s and beyond. Doing it gradually can stretch out and even reduce the tax bill compared to converting it all at once. In your case, the key question is likely whether $90,000 is the right amount to convert each year. Assuming some portfolio growth along the way, this exact conversion plan will reduce the size of the annual mandatory withdrawals later on, but it won’t allow you to avoid them completely. Converting a larger amount each year, on the other hand, will increase your current tax bill. A financial advisor can help you model different scenarios to help you decide which approach makes the most sense for your situation.
Assuming your tax filing status is single and the $125,000 is taxable income after deductions and credits, for the 2023 tax year you are in the 24% marginal income tax bracket. Your bill for federal income taxes will be approximately $20,076. If you convert $90,000 now, that will increase your income to $215,000 and move you into the 32% bracket. Your one-year income tax bill will increase $23,124 to $43,200. Over 10 years, your added taxes owed due to Roth conversions increasing your taxable income would come to approximately $230,000, not accounting for potential portfolio growth and inflation.
Alternatively, you could convert the entire $900,00 all at once. That would move you into the top 37% bracket and increase your current year income to $1,025,000, Your tax bill would skyrocket to $366,678, an increase of about $130,000 over the staggered approach. Remember, these are simplified calculations. A financial advisor can help you make more sophisticated projections in various scenarios.
Given the tax savings compared to a single-year conversion, gradual conversion seems like a promising strategy. However, doing a set amount each year may not be the most effective approach. If you convert 10% of your IRA each year, for instance, you won’t completely empty your IRA after 10 years. That’s because the remaining balance is likely to increase due to investment returns over that period.
Converting $90,000 annually, while earning 7% average returns, will leave approximately $500,000 still in your IRA after 10 years. Using the IRS tables for calculating RMDs, your first-year mandatory annual withdrawal amount will be just shy of $20,000. This relatively small amount may not cause your income to increase so much that you’re bumped into the next tax bracket. However, if you want to avoid RMDs entirely, you will likely have to convert larger amounts.
In your case, assuming $900,000 starting balance and 7% return for 10 years, you would need to convert approximately $128,000 each year for 10 years in order to have a zero balance in your IRA when you turn 73 and must start taking RMDs. Added to your current income of $125,000, a $121,000 conversion would give you $253,000 in income and move you in the second-highest 35% bracket and result in an annual federal income tax bill of just about $70,000.
It might make more sense to convert only enough IRA funds to bring your income up to the top of your current bracket. For 2024, the top income in your current 24% bracket is $191,950. If you stay under that amount, you can convert $66,950 each year without making the big jump into the 32% bracket.
Simplified examples such as these don’t consider a number factors that could be important. Additional income, changes in tax rates or tax brackets, state income taxes, your planned retirement age, your expected lifespan and future inflation and investment returns are all elements to consider when making plans for a long-term project such as converting your IRA to a Roth IRA.
You may be planning to never take the money from the Roth IRA. This can be a part of an estate plan. If did plan to withdraw money in retirement and you were under age 59 ½, it would be important for you to consider that conversion separately has a five-year waiting period before you can withdraw from your Roth IRA without owing taxes and penalties. However, this five-year rule doesn’t apply if you are over age 59 ½ so it’s not relevant to your case.
Remember, a financial advisor can offer personalized advice for your retirement goals.
Gradually converting your IRA to a Roth IRA can make sense if you want to avoid RMDs later on while managing your current tax bill. However, you may need to convert more than 10% of your $900,000 IRA each year if you want to avoid RMDs as much as possible. The most helpful conversion amount is likely to be one that increases your current taxable income up to the top of your current marginal income tax bracket.
A financial advisor can help you assess the factors that determine how to approach Roth conversion in your specific situations. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three financial advisors in your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
Use SmartAsset’s federal income tax calculator to help you model the tax impacts of various Roth conversion methods.
Keep an emergency fund on hand in case you run into unexpected expenses. An emergency fund should be liquid — in an account that isn’t at risk of significant fluctuation like the stock market. The tradeoff is that 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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