Key Points
Many people aim to move all of their retirement savings into a Roth account before required minimum distributions begin.
There can be benefits to doing a partial Roth conversion instead.
You might save on taxes, avoid Medicare surcharges, and give yourself more options for charitable giving.
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Saving for retirement in a traditional IRA or 401(k) plan is great -- until the IRS starts forcing you to take withdrawals from your account. Those mandatory withdrawals are known as required minimum distributions, or RMDs. And they begin at either age 73 or 75, depending on your year of birth.
Since RMDs can lead to hefty taxes in retirement, a common strategy is to convert a traditional IRA or 401(k) to a Roth IRA before RMDs start. But you may not want to move all of the money in your traditional retirement account into a Roth. Here are three reasons why a partial Roth conversion could be a smarter move for you.
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1. You can avoid jumping into higher tax brackets
Part of the purpose of moving funds into a Roth IRA is to enjoy tax-free withdrawals during retirement. But in the course of moving that money over, you're going to trigger taxes. And if you have a large IRA or 401(k) to convert, doing a complete Roth conversion could mean bumping yourself into a higher tax bracket and facing a huge tax bill as a result.
Of course, one way to potentially avoid this is to spread your Roth conversion out over many years. If you have a $1.5 million 401(k) that you convert to a Roth in a single year, you're generally going to be looking at a gigantic bill. If you do that conversion over a 10-year period, the taxes shouldn't be as painful year to year.
But you may not have a longer window to do a Roth conversion. If you're 68 and still employed, earning a generous salary, and you don't plan to retire until 70, that gives you three years to do a Roth conversion. If you have a large sum of money to move over, you may land in a high tax bracket each year. In a situation like this, a partial conversion could make more sense.
2. You can reduce conversion side effects
Roth conversions don't just trigger taxes on the amount of money you move over each year. They can also have other hidden consequences.
For one thing, Roth conversions add to your income, making it more likely that you'll have to pay taxes on your Social Security benefits. Roth conversions could also lead to higher Medicare costs, known as income-related monthly adjustment amounts, or IRMAAs.
IRMAAs could potentially add hundreds of dollars a month to the cost of Medicare. And if you're doing Roth conversions in your mid- to late 60s when you're already enrolled, you risk paying more for Medicare Parts B and D for years if you're moving over a large balance. You may want to consider a partial conversion to mitigate that pain.
3. You can retain a tax break for charitable giving
If you've saved a lot of money for retirement and plan on giving a portion of it to charity in your lifetime, then it pays to keep some funds in a traditional IRA rather than move all of your money into a Roth. Qualified charitable distributions, or QCDs, allow you to transfer money each year to a qualifying charity.
The nice thing about QCDs is that they satisfy RMDs while helping you avoid taxes in the process. And while QCD limits can change annually, they're pretty generous. This year, you can donate up to $111,000.
Let's say you have a $1.5 million IRA and want to donate $100,000 of it to a charity that's important to you. If you convert that $100,000 to a Roth, you'll pay taxes on that amount. If you donate it via a QCD, you won't.
Roth conversions can be a strategic retirement planning move that benefits you in many ways. But before you rush to move all of your savings into a Roth, consider the advantages of leaving a portion of your nest egg in a traditional retirement plan instead.
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