At 72, Janice Campbell may not seem to be the common Roth account investor. These kinds of investments – funded with taxed dollars moderately than the tax-free contributions that go into most individual retirement accounts and 401(k)s – are typically really helpful for younger staff.
The money is taxed before it’s paid into the account. For young professionals with entry-level salaries, it’s attractive to pay a lower tax rate than is prone to be the case in 20 or 30 years. This money grows tax-free until retirement, after which withdrawals are also tax-free.
But Ms. Campbell, a retired engineer who stays lively and healthy and continuously hikes the paths round her Arizona home, worries about how her health might change in the approaching years and whether she might face the fee of long-term care.
“I think it’s important at our age not to burden our children or grandchildren with that burden,” said Ms. Campbell. So, on the advice of her financial advisor, she recently decided to vary her investment mix and is converting a part of her retirement savings right into a Roth IRA.
“I probably won’t need the money until later and it can just grow,” she said.
Advisers like Andrea Clark, who works with Ms. Campbell, say contributing or converting funds right into a Roth account can provide significant tax and estate planning advantages for older staff and retirees.
Ms. Clark, owner and founding father of Table Financial Planning, based in Fountain Hills, Arizona, said a Roth account offers the flexibleness of a tax-free pot of cash that may be drawn upon for giant or unplanned expenses.
As Ms. Clark explains, money from tax-free accounts like a 401(k) plan is taxed on the peculiar income tax rate, so a big withdrawal, say to cover nursing home costs, can easily send someone right into a much higher marginal tax bracket and potentially cause a pointy increase in Medicare premiums.
Financial experts say that is a superb time for people seeking to convert existing retirement accounts from tax-free to Roth because income tax rates are historically low and can rise again after 2025 unless Congress intervenes. In addition, Roth accounts can protect heirs from high tax bills on inherited IRAs.
“It may make the next few years a little more advantageous,” says Matt Hylland, a partner at Arnold & Mote Wealth Management in Hiawatha, Iowa. He and other experts in the sector say there are several good arguments for having a pile of tax-free money available in retirement.
First, there’s uncertainty about what tax rates can be in the long run. The Tax Cuts and Jobs Act of 2017 lowered individual tax rates, but those cuts were temporary and expire at the tip of next 12 months. If lawmakers don’t act, the marginal tax rate for top earners could fall back to about 40 percent.
Jeremy Eppley, founding father of Silverstone Financial in Owings Mills, Maryland, believes the high national debt will prompt the federal government to lift taxes in the long run. “It’s unlikely that taxes will stay this low in the long term,” he said.
Retirees or people nearing retirement who’ve built up large balances of their accounts through tax-free contributions could find themselves in an unexpectedly high tax bracket when they have to begin taking required minimum distributions at age 72 (73 for individuals who were 72 or younger in 2024), especially if additionally they produce other taxable income streams, akin to a pension.
John Moore, a retired engineer and client of Mr. Hylland who lives in Cedar Rapids, Iowa, said he apprehensive that financial setbacks and the Great Recession had left him without enough money for retirement. “I knew if I wanted any chance at all in retirement, I would have to save like crazy,” he said.
But Moore, 65, said he hadn’t considered the implications of getting more taxable income if he had to begin taking required minimum distributions. “When I saw the numbers, it wasn’t rocket science to figure that out,” he said. He is now undergoing a multi-year process to convert a few of his tax-free retirement savings to Roth.
Hylland said it is a common oversight amongst people just entering retirement. Many people have a look at the primary few years of their retirement and say, ‘This is great, I actually have a lower tax rate.’ It’s only later that this really sinks in,” he said.
When should it’s done?
People who are still working may be able to make Roth contributions through their employer’s 401(k) plan. According to Vanguard’s 2024 How America Saves report, 82 percent of employer 401(k) plans offer a Roth option. Unlike Roth IRAs, which have income restrictions, any eligible worker can contribute to a Roth 401(k). Another option for high earners is a Roth conversion.
People who work part-time or are in the early years of their retirement — especially if they are living off savings and are not yet collecting Social Security benefits or making withdrawals from their retirement accounts — have a good chance of making Roth conversions because their lower taxable income puts them in a lower tax bracket.
Money contributed to a Roth account is counted as income and taxed at the ordinary income tax rate. Financial advisers say they work to “fill” the tax brackets without triggering a jump to the next marginal tax bracket. For example, a single person earning $150,000 in 2024 could convert up to $41,950 from a traditional retirement account to a Roth account without their income exceeding the $191,950 threshold for the 24 percent tax bracket.
In addition to income tax rates, there are other income-based programs and credits that can put people at risk if they convert too much money to Roth in a given year—and increase their taxable income. For example, people could lose tax credits for health insurance plan premiums or become ineligible for income-based student loan repayment programs. For parents with children who are currently in college or will soon be in college, a jump in income offset by a Roth conversion could affect eligibility for financial aid. For older retirees who already receive Social Security and Medicare, a jump in income could mess up their tax calculations and lead to higher Medicare premiums.
Then there’s the question of the tax burden on these conversions. Advisors advise against withdrawing more than the amount you plan to convert to cover taxes, because money not transferred to a qualified retirement account is treated as a withdrawal. For those under age 59½, that would result in a 10 percent early withdrawal penalty in addition to the ordinary income tax payable on that money.
Advisors recommend that investors think about conversions early so that they have enough time to avoid such events by converting gradually.
“If we have now enough wiggle room, it may possibly be a small amount per 12 months,” said Luis Rosa, founder of Las Vegas-based Build a Better Financial Future. “If you may have at the least five years or more, that is ideal,” he said, because it gives investors the flexibility to decide how and when they want to pay taxes.
“Do you want to pay taxes on the seed or the harvest?” he said.
