Take Advantage of Your Tax Holiday
The IRS must have a special affection for those in their 60’s. Maybe it is their consolation prize for all those years of tax payments. Either way, kick of your 60th birthday early at 59 ½ because their gift to you is elimination of the 10% penalty for distributions from your IRAs.
For those fortunate enough to be considering retirement in their 60’s, this period can be a great time to take advantage of the tax difference between Roth IRAs and Traditional IRAs. This is particularly pertinent to those in their 60’s today since a many people in this demographic were never able to utilize Roth IRAs to the full benefit since they only came into law in 1997. And even then, they did not enter many company retirement plans until recently. If you are in you 60’s my guess would be that majority of your retirement savings is in a Traditional, Pre-Tax IRA. This means that when you go to use your retirement account you must pay ordinary income tax on every dollar that comes out. In the eyes of the IRS, every dollar that comes out of your IRA will be like you went to work and earned that dollar. In other words, not all the money in your IRA is yours, the IRS has had their eyes on it for years and it is now time to pay the piper.
Here is the thing though. Even though you can start your distributions at 59 ½, you do not have to until 70 ½. You can keep your money invested and tax-deferred for another 11 years. For many this window also coincides with scaling back from work and maybe even full retirement, reducing their income and taxes. We call this a tax holiday and a great opportunity to potentially boost your retirement portfolio. The tool is called a Roth-Conversion. The IRS allows you to convert your Traditional IRA to a Roth IRA any year without limit. You can turn those pre-tax dollars into post-tax dollars. The trick is that they count every dollar you convert as income in that year. So, if you decide to convert $100,000 of your Traditional IRA, you will be taxed on the full $100,000 as ordinary income. For those in the tax holiday described above, they can take advantage of their lower income and lower tax bracket by doing several Roth conversations up through their 70s. Traditional IRA account owners should consider the tax ramifications, age and income restrictions in regards to executing a conversion from a Traditional IRA to a Roth IRA.
Here is an example:
Jack and Diane are 65 and beginning to consider retirement. They have spent their lives building up their investments in their 401(k)s and some other taxable investments in stocks and other various investments. They also have some money in the bank that they have built up over the years. Prior to this year, they were making over $200,000 combined but now have scaled back from work and will only have taxable income of $50,000. They are fortunate enough to not have to use their 401(k)s yet and will supplement their income with their other investments and their savings. They can use Roth Conversions to peel pieces of the pre-tax IRAs away and move them into Roth IRAs without increasing their tax bracket. In this case the 25% tax bracket is for income between $37,950 to $91,900 for 2017. Meaning they can move $41,900 out of their IRAs without increasing their tax bracket ($91,900 minus $50,000). By doing this they reduce their future minimum required distribution (MRD) from the pre-tax accounts, create a portion of inheritance that is tax-free, and potentially reduce their future tax bill. Based on current tax brackets, from 65 to 70 they could move close to $250,000 out of their pre-tax IRAs at the lower tax bracket they are enjoying.
Roth Conversions in your 60’s can be great planning technique but require a lot of calculating and should be coordinated with your tax advisor. If you are fortunate enough to not absolutely need your retirement accounts when you first start to retire, consider Roth Conversions as a tool to boost your portfolios.