Got the RMD blues? That is to say, is the never-ending merry-go-round of annual taxable required minimum distributions from your IRA getting you down? It wouldn’t be surprising if it were, particularly if you don’t need the money or if you’re regularly incurring the 25% penalty for not completing your required minimum distributions in time.
Although you can never actually escape taxation, you can get it over with once and for all while still leaving your money in a tax-sheltered retirement account.
What are RMDs?
Simply put, RMDs are IRS-required minimum distributions from ordinary retirement accounts once you turn 73. The “minimum” depends on your age and the value of your IRA at the end of the previous calendar year.
The required minimum withdrawal for the year you turn 73 is roughly 3.7% of the IRA’s value. However, at 80, it’s 4.95% of the prior year’s ending balance. At 87, your RMD ratchets up to 6.94%. At age 93, plan on withdrawing at least 9.9% of the retirement account’s value as of the end of the prior year. The IRS’s goal is to make sure your IRA is emptied out by the time you turn 120, so it raises your RMD as you age.
What if there were a way to permanently reduce — if not outright eliminate — your required minimum distributions and any penalty for missing them? You can convert your ordinary IRA to a Roth IRA.
A Roth conversion?
Roth retirement accounts are taxed differently than ordinary IRAs. Whereas contributions to regular retirement accounts are typically tax-deductible and withdrawals from them are taxed, contributions to Roths aren’t tax-deductible, but distributions from them are tax-free. In fact, you’re not required to make any distributions from Roth accounts.
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There’s a catch in converting an ordinary IRA to a Roth: This entire transaction is treated as taxable income. If it’s going to be sizable, making the conversion could push you into a higher tax bracket. That’s why you might want to stagger a conversion out over multiple years.
The cost may be worth it though, particularly if you can cover the tax bill. See, there’s no rule that says you must pay the income tax stemming from a conversion with money from the retirement account in question. The IRS just wants the amount it’s due.
Regardless, once completed, you’ll not need to worry about taking minimum distributions — or being penalized 25% for missing them — from the converted savings ever again.
Just think it through first
There are some rules to consider, including for beneficiaries. For instance, anyone inheriting a spouse’s converted Roth may still be required to take distributions from it, depending on how it’s treated at the time. Be sure to check with a qualified professional familiar with your situation to ensure a Roth conversion will actually accomplish what you want it to.
Also, a Roth conversion may or may not actually save you money. You’re only accelerating your IRA’s taxation while leaving these assets in a retirement account where they can continue growing tax-free. If you’re not going to leave this converted money alone or pay the tax bill without borrowing, though, there may be no net upside for you.
Given how it might benefit you, however, it wouldn’t be crazy to do a little comparative number-crunching with the idea.
