You can perform a Roth conversion at any age, and potentially produce a noticeable boost to your retirement income.
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You can perform a Roth conversion at any age, and potentially boost your retirement income. However, this strategy often produces more positive results the sooner it’s done. One reason is that you have to pay taxes on converted funds at the time of the conversion. After all, money sent to the IRS can’t be invested and grown. Roth conversions may make the most sense if you expect to be in a lower tax bracket after retirement, as well as if you plan to leave retirement savings to any heirs as part of your estate plan. Ultimately, whether converting a 401(k) at 62 is your best move depends on your individual circumstances beyond just the amount in it.
A financial advisor can help you assess your options.
If you’re 62 and have $850,000 in a 401(k), before committing to a Roth conversion, you’ll want to consider several factors. Among other things to think about are your current income, when you plan to retire and how much your income will be in retirement.
Let’s say you currently have $100,000 in taxable income, are single and will retire at 66. If you convert the entire 401(k) now, your taxable income for this year will equal $950,000, including $850,000 in converted funds plus $100,000 in other taxable income. This will put you in the 37% marginal income tax bracket, with an income tax bill of approximately $304,284, as calculated by SmartAsset’s Federal Income Tax Calculator.
If you use some of the converted funds to pay taxes, that money won’t be available for tax-free growth for four more years. Of course, you’ll still have $545,176 in your Roth account after deducting tax payments. Four years of 7% annual growth from investing that will produce a balance of $714,615, according to SmartAsset’s Investment Return & Growth Calculator.
Now let’s look at the scenario of not converting. In four years, assuming 7% average annual growth, your $850,000 401(k) balance will have increased to $1,114,177. That’s $399,562 more than you would have after converting.
However, you also have to consider taxes on your income in retirement. Start with Social Security. Assuming you claim at age 66, those benefits are likely to be $40,560 a year, according to SmartAsset’s Social Security Calculator.
Now add 401(k) withdrawals. At the 4% safe withdrawal rate from a $1,114,177 balance, you’ll take out about $44,567 in the first year of retirement. (RMDs won’t be a factor since you’re already withdrawing more than the scheduled RMD amount.)
With that much income, 85% or $34,476 of your Social Security benefit likely will be taxable. So will the $44,567 from your 401(k), so total taxable income will be $79,043. Tax on that amount comes to an estimated $15,277. Subtracting the tax charge from total income yields after-tax income of $63,766.
Next, consider the conversion scenario. A 4% safe withdrawal from your $714,615 Roth balance at age 66 produces $28,584 in tax-free funds. Because the Roth withdrawal doesn’t increase the combined income figure used to figure taxes on Social Security benefits, those benefits will also be tax-free. Total after-tax income will be $28,584 from the Roth and $40,560 from Social Security or $69,144.
Using this simplified model, converting could provide additional annual income in retirement of $69,145 minus $63,766, or $5,379. You may be able to boost this further if, instead of converting the entire 401(k) now, you convert it gradually over several years. Note that a gradual conversion may not completely empty the account by the time RMDs become due. However, that’s not all bad, as RMDs due on the reduced balance would be smaller and have less of an effect on your taxes.
There are other considerations to keep in mind. Estate planning could be one. If you plan to leave retirement savings to your heirs, a bequest from a Roth account will be more valuable because they won’t have to pay taxes on it.
Also consider marital status. If you are married now or may marry later on, consider how filing as a married couple will change both your taxable income and tax bracket. Also look at what might happen when one spouse dies and the survivor begins filing singly again.
There’s more. Income from conversion also could cause your Medicare premiums to rise sharply. In addition, you may become ineligible for some tax credits like the Premium Tax Credit. Finally, you’ll want to be sure you’re certain this is something you want to do before going ahead with a conversion, because it’s irreversible and can’t be undone.
A financial advisor can help you determine whether or not a Roth conversion suits your situation and needs.
Converting an $850,000 401(k) to a Roth account at age 62 is legally and technically feasible, and the strategy could potentially save on taxes down the road, as well as provide your heirs with a tax-free inheritance. However, it may not have a large overall impact on your retirement finances because of the requirement to pay taxes on any converted funds as soon as you perform the conversion. Your individual circumstances, including your current income, marital status, expected age at retirement and tax bracket after retirement, are all factors to consider when assessing whether conversion is the best move for you.
Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
Use SmartAsset’s Retirement Calculator to see how you’re doing with financial preparations for retirement.
Keep an emergency fund on hand in case you run into unexpected expenses. An emergency fund should be liquid — in an account that isn’t at risk of significant fluctuation like the stock market. The tradeoff is that the value of liquid cash can be eroded by inflation. But a high-interest account allows you to earn compound interest. Compare savings accounts from these banks.
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