Benefit of Roth Conversions in Retirement

Jeff Witz, CFP®

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The IRS says that you cannot keep pre-tax retirement funds in your retirement account indefinitely. At a certain age, the IRS mandates you must start taking distributions. These forced distributions are commonly known as Required Minimum Distributions (RMDs). Many physicians worry about the impact RMDs will have on their taxes in future years.

With recent changes under the SECURE Act in early 2020, the IRS now mandates that RMDs begin by age 72 instead of age 70 ½. The RMD for any given year is calculated by taking the account balance as of December 31 of the previous year and dividing it by a factor obtained from the IRS’ published tables based on the age of the account owner. It can also be impacted if a spouse beneficiary is more than 10 years younger than the account owner.

Anytime you make a distribution from a retirement account like a 401(k), 403(b), 457, Traditional IRA, or any other retirement account in which pre-tax dollars were contributed, you must include that distribution amount in your income and pay income taxes on it. Depending on your tax rate that year and the size of the distribution, the tax hit can be substantial.

Therefore, many physicians look for ways to reduce their RMDs before they are required to start taking them, and one of the most effective methods is a Roth conversion. When a physician retires, they typically have a decline in income and thus fall into a lower tax bracket. Their income needs are often satisfied by drawing from their savings, Roth accounts, and smaller distributions from their retirement accounts if they are over age 59 ½. This presents an opportunity to make additional distributions from their pre-tax accounts in the form of Roth conversions.

A Roth conversion is when you take an amount from your pre-tax account, convert it to Roth dollars, pay the applicable taxes, and transfer it into a Roth account. Roth accounts do not have RMDs since the money has already been taxed. These funds can continue to grow tax free and are distributed tax free when a need arises.

Many physicians can distribute amounts from their retirement accounts that satisfy their retirement income needs and have room leftover to convert additional amounts without putting them into a higher tax bracket. Here is an example of how that works:

A 65-year-old married physician needs $120,000 of annual pre-tax retirement income. Through distributions from business interests, investment properties, and pre-tax retirement accounts, they can generate the income they need. This $120,000 of income places the physician in the 22% married, filing jointly federal income tax bracket. This federal tax bracket spans from $78,951 to $168,400 of income. This physician can then convert an additional $48,400 ($168,400-$120,000) from their pre-tax account without it bumping them into a higher tax bracket. However, for practical purposes, they will want to convert a little less and leave themselves a cushion in case their math is not perfect. It is critical not to get it wrong and end up in a higher tax bracket.

By completing this process, a physician can reduce the balances in their pre-tax retirement accounts and in turn reduce their RMD obligations once they turn age 72. The money will still grow in a tax-advantaged Roth account, and it will place them in a more flexible tax position in the future.

Due to the precision required to convert appropriate amounts, we highly recommend you speak with a CPA and financial advisor to make certain the calculations are correct.

Jeff Witz, CFP® welcomes readers’ questions.  He can be reached at 800-883-8555 or at witz@mediqus.com.

200 North LaSalle Street – Suite 2300 – Chicago, Illinois 60601

312-419-3733 – Toll Free 800-883-8555 – Fax 312-332-4908 – www.mediqus.com

Investment advisory services offered through MEDIQUS Asset Advisors, Inc. Securities offered through Ausdal Financial Partners, Inc.  Member FINRA/SIPC ∙ 5187 Utica Ridge Rd ∙ Davenport, IA 52807 ∙ 563-326-2064 ∙ MEDIQUS Asset Advisors and Ausdal Financial Partners, Inc. are independently owned and operated.

 

 

Effective June 21, 2005, newly issued Internal Revenue Service regulations require that certain types of written advice include a disclaimer. To the extent the preceding message contains written advice relating to a Federal tax issue, the written advice is not intended or written to be used, and it cannot be used by the recipient or any other taxpayer, for the purposes of avoiding Federal tax penalties, and was not written to support the promotion or marketing of the transaction or matters discussed herein.

The information contained in this report is for informational purposes only. Any calculations have been made using techniques we consider reliable but are not guaranteed. Please contact your tax advisor to review this information and to consult with them regarding any questions you may have with respect to this communication.

MEDIQUS Asset Advisors, Inc. does not provide tax, legal or accounting advice. This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, tax, legal or accounting advice. You should consult your own tax, legal and accounting advisors before engaging in any transaction.

 

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