Should we drain our $200,000 savings for Roth conversions on $2.3 million in our 60s?
Decisions about Roth conversion come down to tax rates. – Getty Images
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My wife and I are contemplating doing Roth conversions with part of our IRAs. We were thinking of doing monthly conversions, but don’t know if we should take the taxes due out of the conversions themselves or pay them out of our savings. We have $200,000 in our savings, but are hesitant to start draining savings for it.
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I’m 66 and my wife is 65, and we have monthly pensions and Social Security that total, before taxes, $10,900 a month. Our home is paid off and we have zero debt. We don’t need to withdraw any money from our IRAs, but we will have to once we turn 73 for required minimum distributions (RMDs). My IRA has $1.1 million now and my wife’s IRA has $1.2 million.
We are worried about a couple things as we approach our later years. What impact will RMDs have on our taxable income? What about higher and additional premiums on Medicare? We’ve spoken to our accountant and our financial adviser at our IRA custodian, as well as a few others, and cannot get clarity as to whether we should or shouldn’t do conversions.
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You are in a good spot to consider Roth conversions, although many financial advisers I talk to say to start even earlier — before age 63 if you can.
That doesn’t work for everyone though, because many people are still working at that age. The reason they suggest this is because of the Medicare issue you bring up, with surcharges for high income. To determine your monthly Medicare premium each year, the government looks back two years. So when you start at 65, they’re looking back at your income when you were 63. The surcharges for what’s called IRMAA start at $212,000 for married couples in 2025 ($106,000 for singles).
If you’re bringing in roughly $130,000, you have some room to do conversions before you hit that threshold, at least until you have to start taking RMDs. If you don’t touch your IRAs, your combined $2.3 million could be worth $3.7 million by the time you hit the age you have to start taking money out. Your combined RMDs once you both start could be $140,000 a year; that’s considering average 7% growth, and is just a rough estimate. Even with just your pension income, you would mostly likely be paying tax on up to 85% of your Social Security benefits.
IRMAA and Social Security taxes should not be your main concern, however. The key to Roth conversion decisions is your current tax rate versus your future tax rate. It might seem like an emotional question or subjective in some way — people often feel they should be doing something — but it’s all about math.
The tricky thing about advanced math, however, is that sometimes you have to solve for unknown variables. You know your tax rate now, but what you don’t know is your tax rate in the future. You can guess, though; your financial adviser should be able to run a scenario analysis to project your future income, and thus the potential taxes. If not, then you can do this on your own with online calculators or a spreadsheet, if you’re handy with those. What you’re looking for is exactly what’s above — which is to calculate out what your savings will be worth in future years, with different growth parameters and different withdrawal patterns.
If your income right now is $130,000, you’re in the 22% bracket. If you leave everything alone until you are RMD age, you might have an income of $270,000 or more, and that would put you in the 24% bracket. If you do a Roth conversion up to the top of the 22% bracket, which is currently $206,700 for married couples, you’d potentially save on the tax arbitrage. You might convert about $75,000, which would presumably cost you around $17,000 in taxes, but maybe more depending on your state. You could see again next year if you want to do it all again, if the math makes sense, and keep doing it until you reach RMD age.
Why stop when you reach RMD age of 73? The key reason is that you have to take the RMD out first, before you can consider any Roth conversion — and when most people do that, the math stops making sense. You’d already be deep into the 24% bracket after the RMD, and a conversion could even push you into the 32% bracket. Then it’s costing you more than just leaving the money where it is, and what you’re trying to avoid with Roth conversions is paying more tax than you have to.
Taking $17,000 out of your $200,000 savings does not sound like the biggest bite, but if you do that for seven years in a row, it’ll start to have an impact on your cash flow. The issue with paying for Roth conversions out of the conversion itself, by the way, is that it’s inefficient taxwise. Say you’re taking out $100,000, for easy calculations: You’ll be paying $22,000 in tax, and only getting to put $78,000 in the Roth IRA. That math is better when you put in the full $100,000 and pay $22,000 in taxes.
The bigger issue with all of this is what else you’re going to do with the nearly $4 million you’ve accumulated over your lifetime. Are you going to spend it? If so, then maybe the best answer for you is to just take as much money as you want out of your IRA, pay the taxes and keep what you don’t spend in a regular savings account.
If there’s money left when you both die, then you can figure out what to do with that. If you’re going to leave it to charity, it’s more efficient to just leave it where it is and donate the accounts directly or give it away as you go, with qualified charitable distributions and other gifts.
If you’re going to leave it for your children, then you might want to consider their future tax rates. But that can get tricky, because you’re both still young. You have to consider a long time frame — it could reasonably be another 30 years before anyone inherits money from you. Nobody can give you a definitive answer on this, because it’s largely up to you what you do with your money. You just have to look at your whole situation and choose the option you like best.
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