In a recent column, you stated that the only way to avoid paying taxes on required minimum distributions, known as RMDs, is to donate them to charity. I’m thinking of another way — converting to a Roth. When is it a good idea to convert to a Roth? Depending on how much you pay in taxes on the amount you withdraw to convert, and your average investment return in the Roth, there should be a break-even point.
You can indeed reduce or even eliminate taxes on future RMDs by converting some or all of your tax-deferred IRA to a tax-free Roth. Of course, you pay current taxes on the amount you convert.
Many financial advisers say the best time to consider doing partial annual Roth conversions is between the ages of 60 and 70, when you’re no longer subject to an early-withdrawal penalty on IRA withdrawals.
A key factor in this decision is the break-even point — i.e., how soon you’ll be financially better off than if you hadn’t done the conversion. But there’s no quick way to calculate the answer because it depends on many factors.
One is the Roth’s future investment return, as you say. Another is how long you can let it grow untouched, relying on other sources of income to cover your expenses. The longer, the better. You can’t break even if you take Roth withdrawals at a faster rate than the account can grow. Another important consideration is whether you’re taxed on the conversion at a lower rate than you’re likely to pay on future RMDs. That’s why the best time to convert an IRA is a year in which your deductions will offset the conversion tax.
THE BOTTOM LINE Consult your tax accountant or financial planner about your individual situation before deciding to do a Roth conversion.
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