Q.: I understand that prior to 70½, I can convert as much of my retirement accounts as I want to a Roth and the Roth will not be subject to RMD (required minimum distribution). My wife works. I do not. We will both turn 62 next year. How do I decide how much to convert?
— Brian in Toledo
A.: Brian, generally you want to convert as much as you can so that the tax rate that applies now is lower than the tax rate you would face later. If converting means you would pay a higher rate now than would apply later, you would not want to convert anything.
This can get tricky but what you want to do is lay out year by year, all your income sources and deductions. Then, overlay the tax code on those figures.
For each year going forward, list what you and your wife expect to take in for wages, required minimum distributions from retirement accounts, Social Security and any other income. Total these to come up with an annual gross income.
Then, list what you think your deductions will be (itemized or standard). Subtract the deductions from your gross income and you have a taxable income estimate for every year.
Once you’ve arrived at taxable income you’re able to estimate which tax bracket will apply to you each year. You may see that you are in a lower bracket when your wife stops working and no longer collects a paycheck, particularly if that happens before age 70½ when RMD starts. These low bracket years are opportunities to consider converting.
You could convert to Roth enough to use up the low brackets. By the time you reach 70 ½ and must take RMD, the amount in the retirement accounts will be lower than if you did not convert resulting in a lower RMD.
That seems simple enough, but there are complications. For instance, the more you convert or otherwise distribute from your retirement accounts while receiving Social Security, the more those Social Security payments become taxable. That’s another point on the year-to-year outlook that needs to be factored in.
Further, estimating your deductions is a bit of a guessing game. Do you really know what your medical expenses will be in future years? How certain are you that you will be more, or less, charitable in the future? A more conservative approach than estimating itemized deductions would be to simply use the standard deduction each year. And let’s not forget that many of the rules surrounding taxation of individuals are set to revert to the 2017 structure in 2026. The new increased standard deduction and the new lower tax rates will disappear without more legislation.
Plus, over eight years, your retirement accounts are likely to grow so you must factor that into your estimates for RMD.
There are quite a few things to discuss with your financial planner. The primary strategic issue though is identifying years in which the tax rate applicable is low enough that you are confident that paying at that low rate will be less costly than paying later.
If you have a question for Dan, please email him with “MarketWatch QA” on the subject line.
Dan Moisand’s comments are for informational purposes only and are not a substitute for personalized advice. Consult your adviser about what is best for you. Some questions are edited for brevity.
Dan Moisand is a principal at Moisand Fitzgerald Tamayo, LLC in Melbourne and Orlando, Fla. He is a happily married father of two, a past national President of the Financial Planning Association, has been featured as one of America’s top financial planners by at least 10 financial planning publications.
We Want to
Hear from You
Join the conversation