1It may also be possible to convert assets from pretax to Roth within a retirement plan such as a 401(k) plan. While many of the planning principles are the same, this paper focuses on conversions of IRAs.
2A qualified distribution is tax-free if taken at least 5 years after the year of your first Roth contribution AND you’ve reached age 59½, become totally disabled, or died or you meet the requirements for a first-time home purchase. If the distribution from your Roth IRA is not qualified, the earnings may be taxable. Additional taxes may apply for early withdrawals.
3This analysis builds upon T.RowePrice’s February 2015 paper by Judith Ward, CFP®, “How to Minimize Unwanted RMDs Using a Roth IRA Conversion Strategy.”
4Assumptions for all cases: A married couple has an annual taxable income of $225,000 and is in the 24% federal tax bracket. The income level is such that Roth conversions ($40,000 annually during the relevant years) do not change their federal tax bracket. State income taxes are not considered. (This approximately reflects the state tax rate not changing from working years to retirement.) The couple has $500,000 saved in Traditional IRAs that they do not expect to need for retirement income. The fact that they have other income sources is important, but the analysis does not need to reflect those assets or cash flow streams. One spouse contributes $8,000 annually to a Traditional IRA from age 55 until age 65. The couple also has $130,000 in a taxable account that can be used to pay taxes on the Roth conversion (using assets without gains, so there is no additional tax due to liquidation). This account will also be used to invest RMDs from the Traditional IRAs (since RMDs are not needed for retirement spending). All accounts have 6% annual investment returns, before taxes. All capital gains are taxed at the 15% rate. RMDs are assumed to be taxed at the marginal rate (not across multiple tax brackets), which stays steady through retirement. RMDs are based on rules in effect on January 2, 2024, including a beginning age of 75 for people who are currently 55.
5Kutner, George W., Doney, Lloyd D., Trebby, James P., “Investment Performance Comparison Between Roth And Traditional Individual Retirement Accounts,” Journal of Applied Business Research (JABR), [S.l.], v. 17, n. 1, Feb. 2001. ISSN 2157-8834. Available at: cluteinstitute.com/ojs/index.php/JABR/article/view/2064.
6This analysis assumes the taxable account generates only earnings at 0% or capital gains rates, not at ordinary rates. (This reflects a person who carefully manages assets across account types.) It also assumes the heirs’ tax rate is the same as the person’s tax rate during retirement. Starting amounts in the accounts, as well as the amount of annual conversions, are adjusted proportionally based on approximate income levels for the starting tax brackets. The analysis is based on starting conversions at age 55. Other assumptions are consistent with the analysis summarized in Figure 1.
Important Information
This material has been prepared by T.RowePrice Investment Services, Inc., for general and educational purposes only. This material does not provide fiduciary recommendations concerning investments or investment management. T.RowePrice Investment Services, Inc., its affiliates, and its associates do not provide legal or tax advice. Any tax-related discussion contained in this material, including any attachments/links, is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding any tax penalties or (ii) promoting, marketing, or recommending to any other party any transaction or matter addressed herein. Please consult your independent legal counsel and/or tax professional regarding any legal or tax issues raised in this material.
The views contained herein are those of the authors as of February 2024 and are subject to change without notice; these views may differ from those of other T.RowePrice associates. All investments involve risk. All charts and tables are shown for illustrative purposes only.
An IRA should be considered a long-term investment. IRAs generally have expenses and account fees, which may impact the value of the account. Nonqualified withdrawals may be subject to taxes and penalties. Maximum contributions are subject to eligibility requirements. For more detailed information about taxes, consult IRS Publication 590 or a tax professional regarding personal circ*mstances.
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