Secrets to Roth Conversions and RMDs: Unlocking Retirement Freedom

Can you imagine being 80 years old and paying more taxes in retirement than in your highest-earning years during your working life?

Many of you might think that the odds of this happening are practically impossible. Still, the reality is that this is precisely what will happen to the vast majority of Americans. Let’s look at the main reason.

Traditional 401K accounts are still the most used retirement plan in America.

According to the Vanguard report – “How America Saves. “For every two private sector employees, 1 of them, or 50%, has a defined contribution plan, which in most cases is still under a traditional 401K retirement account”.

According to this report. More than 100 million Americans are covered by a defined contribution retirement plan (401K, IRA, 403B). And these accounts have more than 10 trillion dollars in assets.

Those who earn more. Are older and have more seniority in the company participate more frequently in these retirement plans offered by their employer.

While it is true that the ROTH contribution option is growing, the traditional or tax-deferred route is still the big winner. Covering approximately 83% of the contributions to these retirement plans.

So we can see that in all these so-called traditional accounts. Where most Americans have been saving, Uncle Sam or the IRS is your great partner.

As everyone knows, in so-called traditional retirement accounts. The IRS allows you to reduce your taxes today on the contributions you have been making. The profit that is produced grows without paying taxes until you have to withdraw it. Which is why they are called tax-deferred accounts.

Because tomorrow, when you start to withdraw money from these accounts, that money is considered income. And you will pay taxes on it, both on the contributions you made and the profit that has been produced.

Are RMDs a problem for all retirees?

Let’s explain a little about what Required Minimum Distributions are.

As we have said, the IRS gives you a tax benefit, so your money grows in these tax-deferred retirement accounts.

But the IRS gets a little impatient at some point and says, “This taxpayer has money in his retirement accounts. And I need him to pay my taxes now.”

So, if you still have a balance in these accounts, and generally when you turn 75, the IRS will ask you to make some withdrawals to pay taxes. But the IRS is the one that will tell you how much you have to withdraw.

Suppose you want to know how much you would have to withdraw each year. In that case, Fidelity’s calculator lets you easily visualize the amounts you might have to cancel as Required Minimum Distributions.

Some of you may feel that you won’t have that problem. But rather, you may have a much bigger problem: running out of money in retirement. You may not even have to take any money out of your 401(k). Because you may have run out of balance long before then.

So RMDs are a crucial issue for those who have done their homework throughout their life. And either don’t need to take out the amounts of money that the IRS is going to ask you to take out or maybe you didn’t need to take out as large an amount as you are being asked to take out.

According to Vanguard, those workers between the ages of 55 and 64 have an average balance in their 401K accounts that is 168% higher than the balance of a person between the ages of 35 and 44.

This ratio reaches almost 200% when we compare it to the average balance of a person over 65 years old.

How can a ROTH Conversion strategy help me optimize my taxes?

First of all, let’s begin by explaining what this ROTH Conversion strategy consists of:

As we have see. No one will want to pay more taxes in their last retirement years and when the required minimum distributions arrive. You are forced to withdraw money from your traditional 401K. Which could occur in some cases at age 73, but in most cases in the future. It will begin at age 75.

But we also know that before that time comes. You may have already retired, and you will spend a few years before reaching those 75 years. During which you are not paying as much in taxes because your tax bracket is quite low, because when you are retired, you do not have a higher income.

Therefore, the ROTH Conversion strategy is about optimizing those years. Where you will be in a lower tax bracket and making conversions from your traditional 401K by transferring the money or assets to a ROTH IRA account.

The ROTH Conversion strategy offers a sense of financial security. It allows you to pay taxes in the years of lower tax percentage, enabling your money to continue growing with tax benefits.

At first glance, this strategy makes perfect sense because it allows you to distribute part of the withdrawals where you would pay less taxes. Making you pay a little more in those years to pay less in the future.

On the other hand. If you anticipate future tax rate increases in the United States due to the fiscal deficit. And you believe that we are currently in a period of lower tax rates, a ROTH Conversion strategy could be a wise move. Offering potential benefits in the long run.

As with all tax matters. There are numerous variables to consider when deciding if the ROTH Conversion strategy is right for you. This is where a professional Hourly Financial Planner can be invaluable. Helping you navigate these complexities and determine the best approach for your unique situation.

How do you know if a ROTH Conversion strategy would be right for you?

Let’s do a series of scenarios to try to determine the different people for whom this type of strategy is best suited:

People about to retire:

Are working and perhaps in a reasonably high tax bracket because they have worked all their lives. Still, they want a change in their lives and have already accumulated significant money in their retirement accounts.

In most cases. These people will be in a lower tax bracket when they retire. Because they will no longer have the income from their salaries or bonuses. They may also be over 65 years old. And have already applied for Medicare benefits. And as we said before, much of their money is in tax-deferred retirement accounts.

Many are unaware that when they turn 75. And in some cases, reach 73. They will have to withdraw money according to what the IRS stipulates as Required Minimum Distributions. Which will lead them to pay much more in taxes in their golden years.
Now, perhaps they had an hourly session with a Certified Financial Planner.

And this professional created several scenarios to analyze whether it would make sense for them to do some ROTH Conversions during all these years of their retirement before they reached the time of the Required Minimum Distributions. This would allow them to optimize the use of the different tax brackets.

People who are already retired:

In this scenario, you have already been retired for a while. And know perfectly how much you are receiving from the social security check and what your expenses are.

Life in retirement is no longer a surprise. Rather, you know it very well. But the time is getting closer and closer when you will have to make the Required Minimum Distributions.

You know you are not paying much in taxes. Because your income has been low for some time. But you do not see yourself returning to tax rates that may once again be above 22%.

From what you read, there is a new type of service in the world of financial advice that allows you to have an hourly consultation with a Certified Financial Planner without having to manage your investments because perhaps you are an investor who likes to manage your portfolio yourself or you have an investment advisor who works well for you. Still, their strength is not in financial planning, and you need a second opinion to validate if they can optimize your future taxes.

In these sessions, you realize you can start doing a ROTH Conversion from your Traditional 401K before the IRS mandatory withdrawals start. You may even recognize that you could withdraw more than what the IRS asks you to do when the Required Minimum Distributions begin so you can get out before this, but without moving to a higher tax bracket.

People who are already retired or over 65 years old but with younger partners:

In this scenario, people must take into account something crucial before doing a ROTH Conversion if their partner is under 65 years old and is enjoying the benefit provided by the Affordable Care Act, for which they receive a significant amount as a subsidy in the payment of their health insurance policy.

This is one of those cases where a ROTH Conversion might not be the most appropriate strategy eventually. It is essential that you review the amount that you could lose from the subsidy and compare it to the tax savings you are obtaining.

Again, these calculations can be complex, and there may be better options than a simple online retirement calculator. Hiring a Certified Financial Planner who provides hourly services and helps you run the numbers to determine what is best for you is usually best.

Bonus Tips – Points to Consider Before Doing a ROTH Conversion

1) Impact on the Medicare premiums you pay monthly:

Some clients ask us if it wouldn’t be better to withdraw everything today instead of waiting and having to withdraw an amount every year from their 401K.

As we have already seen, this can lead to much higher taxes because it may put you in a tax bracket with a much higher percentage. It could also make the amount you have to pay for different Medicare coverages in Plans B and D much higher.

2) The 5-year rule:

I think this is one of the most complex rules that the IRS has made, and that could affect those ROTH Conversions and where you want to withdraw the money you converted and that money is less than five years old, the ROTH IRA account, where you will have to pay a 10% penalty as long as you are under 59 and a half years old if you are already over 59 and a half years old this penalty does not apply to you being one of the exceptions allowed by the IRS.

3) If instead you have your money in a traditional IRA account – an Individual Retirement Account or arrangement and the time has come to make your RMD.

You could donate directly from the account to the charity of your choice. If you are over 70 and a half years old, you can donate up to $100,000 a year each year and not pay taxes on that distribution or withdrawal you made; this type of transaction is called Qualified Charitable Distribution (QCD).

Remember, you must always consult these strategies with tax specialists, your CPA, or a Certified Financial Planner. Each case is different; this information is for reference and educational purposes only.

Alonso Rodríguez Segarra – CERTIFIED FINANCIAL PLANNER™

Which provides hourly financial planning services, Fee-Only and Fiduciary. He has over 20 years of experience in the financial world and has been named among the Top 100 Financial Advisors in the US by Investopedia.

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Note: The comments given in this guide are for educational purposes only. Before making a financial decision, you should consult with your financial advisor or conduct appropriate research. Remember that historical results are not a guarantee of future returns. This guide does not take into account tax impacts in the comments provided. Always consult your particular case with a specialist. We are not your financial advisor and remember that each case is different.

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All rights to this guide are reserved, occasional mention of third-party brand names is made solely for educational and reference purposes, without any interest in financial gain. This information is for educational purposes only and does not represent an offer of products or services.