A pension, Social Security and military retirement pay cover our expenses
Dear Dan,
I will be required to start taking withdrawals from my IRA in 2028. My wife and I don’t need the money to pay bills due to my military retirement pay, the pension from my civilian work, and Social Security. Would it be better to do a Roth conversion to avoid required minimum distributions or leave it be and take the RMDs?
Should I Roth?
Dear Should I Roth,
Thank you for your service. Once a Required Minimum Distribution (RMD) is taken, you must contend with the requirement every year as long as you have money in IRAs or retirement accounts.
RMDs can generate high tax bills. Before the onset of RMDs is an excellent time to be thinking of Roth conversions because you can convert any portion of your IRA any time you like. Since your Roth accounts are not subject to RMDs during your lifetime, converting to a Roth account holds some attraction.
Conversions do not avoid taxes, they accelerate taxes. With a conversion, you pay tax now to avoid paying tax later. That pays off when you can pay tax now at a low rate and avoid paying later at a high rate. Determining the applicable tax rate on a conversion for tax year 2024 is fairly easy but determining the future rate you will avoid can be challenging. Many factors can affect your future rate including tax code changes.
For instance, when either of you die, your or your wife’s Social Security check, whichever is the smaller benefit between the two of you, will disappear. If your retirement pay or pension also adjusts down (a common event when a pensioner passes away), and the RMD is modest, the survivor may be in a lower tax bracket than the two of you are today. Lower future rates make a conversion a bad move.
However, when either of you dies, the survivor will file as a single taxpayer in the year after the death. Single filers have a compressed set of tax brackets such that for the same taxable income a married couple pays, a single filer pays more tax. While the possible higher future tax rate caused by the “widows penalty” makes a Roth more attractive, it does not mean a Roth is a no-brainer, because we don’t know how long a widow will stay a single filer. They could remarry which will affect the applicable tax rates or they will pass away themselves.
Ultimately the funds go to heirs. Are you leaving these funds to high-tax-bracket heirs, in which case conversions could preserve money for them? Or, are you leaving to low-bracket heirs or charity? If the heirs are in a lower bracket when they take the funds, conversions make less sense.
In the case where the beneficiary is a qualified charity, conversions can become a flat-out waste of money. It makes no sense to convert and pay larger amounts of taxes now only to leave the remainder to a tax-exempt charity. Naming charities as beneficiaries of IRAs or retirement accounts is an excellent tax planning choice for those with charitable goals but negates the benefits of a Roth conversion. Charitably inclined taxpayers have better options for managing RMDs than converting.
If you have a question for Dan, please email him with “MarketWatch Q&A” on the subject line.
Dan Moisand is a financial planner at Moisand Fitzgerald Tamayo serving clients nationwide from offices in Orlando, Melbourne, and Tampa Florida. His comments are for informational purposes only and are not a substitute for personalized advice. Consult your adviser about what is best for you. Some reader questions are edited to aid the presentation of the subject matter.
Originally published on MarketWatch. Read the original article here.