Q: I read somewhere that you could take money out of your IRA and put it into a Roth after you begin RMDs. Is this possible if you are drawing a pension and not working?
A.: Paul, converting money from a traditional IRA to a Roth IRA is allowable at any age. Whether you are working, receiving a pension, or any other income is irrelevant to whether you may convert.
However, there is an age issue once you are subject to Required Minimum Distributions (RMD). You may not convert any portion of your RMD.
Say your RMD is $30,000. You must first satisfy the RMD by distributing $30,000 out of the IRA. The $30,000 can go to any taxable account (not a retirement account, IRA or Roth IRA), any qualified charities, or any combination of taxable account and charity. You pay whatever taxes result from the distribution.
Once the RMD is satisfied, you may then convert as much of the funds that remain in the IRA as you like to the Roth IRA and pay the taxes caused by the conversion. Your Roth IRA is not subject to RMD so assets converted are left to grow and be used in the future free of tax.
When you convert, you are choosing to pay taxes now to avoid paying taxes later. Therefore, Roth conversions can be an excellent tax planning tactic when the tax rate you would pay now upon conversion is lower than the tax rate that will apply when the funds would otherwise be distributed.
Let’s say you have a RMD of $30,000 but could incur a total of $50,000 of taxable income and still be in a low tax bracket. Once the $30,000 RMD is satisfied, it might be wise to convert an additional $20,000 if you or your beneficiaries will be in a higher bracket in the future when the $20,000 IRA would be distributed. The short-term benefit to you is a slight reduction in your RMDs from the traditional IRA going forward.
If you are charitably inclined, you could satisfy the RMD by making a Qualified Charitable Distribution (QCD). Those can count toward the RMD but are not taxable income to you. For instance, if you wanted to give $10,000 to your church, you would make a donation directly from the IRA. The donation counts toward your RMD so the remaining taxable RMD is $20,000. This means you could convert $30,000 of the IRA to a Roth and still hit that $50,000 total taxable income goal.
With the new Secure Act requiring most nonspouse beneficiaries to distribute inherited IRAs in 10 years or less, many beneficiaries will pay taxes at higher rates than the original IRA and retirement account owners were paying. This makes Roth conversions more attractive to families that are trying to manage the taxation for the benefit of both the IRA owner and the owner’s heirs.
If you have a question for Dan, please email him with ‘MarketWatch Q&A’ on the subject line.
Dan Moisand’s comments are for informational purposes only and are not a substitute for personalized advice. Consult your adviser about what is best for you. Some questions are edited for brevity.
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