23 June 2017

Roth IRA’s “Conversion Zone”

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The start of required minimum distributions from individual retirement accounts is a headache for many affluent investors approaching their 70s. After 70½, even if they don’t need the cash for living expenses, they are required to pull money out each year—and to pay tax on it at ordinary-income rates.

Vanguard Group recently found that 20% of its investors who take an RMD simply divert the funds to a taxable investment account, where it can be left alone without any more required withdrawals.

Vanguard also found that a chunk of its customers start moving money from regular IRAs to Roth IRAs in the decade between age 60 and 70. Part of the appeal is that Roth IRAs don’t have required minimum annual withdrawals. But conversions need to be considered carefully because the dollars converted from a traditional IRA to a Roth are taxed as ordinary income.

The percentage of Vanguard’s total IRA holders converting isn’t large, but it goes up significantly approaching the age when RMDs begin: In 2013, while 0.5% of traditional-IRA owners converted to a Roth at age 55, by age 62 the percentage had grown to 1% and by age 59, more than 2%, Vanguard found.

Vanguard calls the period from age 60 to 70 the “conversion zone.” In other IRA news, the Internal Revenue Service has made it less complicated for people who save through company-sponsored plans to move money into a Roth by allowing the tax-free transfer of after-tax 401(k) contributions. And Congress is likely to soon consider reviving the IRA charitable rollover, under which IRA holders over 70½ could get a tax break for money transferred to charities.

For individuals who want to shift dollars from a traditional IRA to a Roth, one option is to make a series of partial conversions over a period of years.

Each year, they should be careful about the amount of money they are shifting, says Maria Bruno, a senior investment analyst at Vanguard. Whatever you move is going to be added to your income, so you may want to limit your conversion so you aren’t bumping yourself into a higher tax bracket.

Starting the partial conversions might make the most sense when you are either a pre-retiree or a new retiree, have a low income and haven’t started taking Social Security. That might explain the phenomenon of the “conversion zone.”

Click here to access the full article on The Wall Street Journal. 

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