I'm 60 With $750k in my 401(k). Should I Convert $75,000 per Year to Avoid RMDs in Retirement?

Many retirement savers with sizable tax-deferred accounts like a 401(k) are interested in converting those funds to Roth accounts so they can escape having to pay required minimum distributions (RMDs) and the associated taxes after they retire. It’s not always the right move, in part because of the hefty upfront tax bill on conversions. However, in the right situation, this can be a solid financial move. For instance, a saver who expects to be in a higher tax bracket after retirement may be better off paying taxes on a conversion at their lower current rate now.

Consider weighing the pros and cons of converting your retirement account with the assistance of a financial advisor well-versed in the details of these transactions.

Converting to Avoid RMDs

RMDs are mandatory distributions that retirement savers with tax-deferred accounts must start withdrawing from their accounts starting at age 73 whether they need the money to pay expenses or not. These withdrawals are fully taxable, which can cause retirees to pay more income taxes than they would like and, in the worst case, move into a higher tax bracket.

Transferring funds from a 401(k) or other tax-deferred account into an after-tax Roth account lets retirement savers plan for a future without RMDs, because Roth accounts are not subject to RMD rules. Furthermore, Roth withdrawals are tax-free in retirement, further reducing the retiree tax burden.

The downside of Roth conversion is the current tax bill. Converting $75,000 of 401(k) funds to a Roth increases the saver’s income by $75,000 for that year. Assuming the saver is single with household income of $75,000, this will bump them from the 22% marginal income tax bracket to the 24% bracket. Their federal income tax bill will increase from approximately $8,800 to $26,000.

Find out how much you’ll need to withdraw each year with our easy RMD Calculator.

Required Minimum Distribution (RMD) Calculator

Estimate your next RMD using your age, balance and expected returns.

Quickly estimate your RMDs and when to take them

RMD Amount for IRA(s)

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RMD Amount for 401(k) #1

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About This Calculator

This calculator estimates RMDs by dividing the user's prior year's Dec. 31 account balance by the IRS Distribution Period based on their age. Users can enter their birth year, prior-year balances and an expected annual return to estimate the timing and amount of future RMDs.

For IRAs (excluding Roth IRAs), users may combine balances and take the total RMD from one or more accounts. For 401(k)s and similar workplace plans*, RMDs must be calculated and taken separately from each account, so balances should be entered individually.

^*The IRS allows those with multiple 403(b) accounts to aggregate their balances and split their RMDs across these accounts.

Assumptions

This calculator assumes users have an RMD age of either 73 or 75. Users born between 1951 and 1959 are required to take their first RMD by April 1 of the year following their 73rd birthday. Users born in 1960 and later must take their first RMD by April 1 of the year following their 75th birthday.

This calculator uses the IRS Uniform Lifetime Table to estimate RMDs. This table generally applies to account owners age 73 or older whose spouse is either less than 10 years younger or not their sole primary beneficiary.

However, if a user's spouse is more than 10 years younger and is their sole primary beneficiary, the IRS Joint and Last Survivor Expectancy Table must be used instead. Likewise, if the user is the beneficiary of an inherited IRA or retirement account, RMDs must be calculated using the IRS Single Life Expectancy Table. In these cases, users will need to calculate their RMD manually or consult a finance professional.

For users already required to take an RMD for the current year, the calculator uses their account balance as of December 31 of the previous year to compute the RMD. For users who haven't yet reached RMD age, the calculator applies their expected annual rate of return to that same prior-year-end balance to project future balances, which are then used to estimate RMDs.

This RMD calculator uses the IRS Uniform Lifetime Table, but certain users may need to use a different IRS table depending on their beneficiary designation or marital status. It's the user's responsibility to confirm which table applies to their situation, and tables may be subject to change.

Actual results may vary based on individual circumstances, future account performance and changes in tax laws or IRS regulations. Estimates provided by this calculator do not guarantee future distribution amounts or account balances. Past performance is not indicative of future results.

SmartAsset.com does not provide legal, tax, accounting or financial advice (except for referring users to third-party advisers registered or chartered as fiduciaries ("Adviser(s)") with a regulatory body in the United States). Articles, opinions and tools are for general informational purposes only and are not intended to provide specific advice or recommendations for any individual. Users should consult their accountant, tax advisor or legal professional to address their particular situation.

Another potential problem with converting is that rules prohibit tax-free withdrawals of converted contributions for five years. In the majority of cases, the five-year rule means they may have to pay taxes on Roth withdrawals unless they delay retirement until five years after conversion.

Further, while converting will avoid RMDs, it may not reduce the overall tax burden compared to not converting. For instance, it’s possible a retiree may be in a lower tax bracket after retirement. If that happens, it may save money to leave funds in the tax-deferred account and pay the taxes on withdrawals after retirement.

It’s important to keep in mind the fact that conversions cannot be undone. It is strictly a one-way procedure, so a saver is well-advised to be absolutely sure that this is the right move before executing a conversion.

Roth Conversion Strategies

Gradually converting 401(k) funds to a Roth through a partial Roth conversion can help manage and potentially reduce the overall tax bill. For instance, converting the entire $750,000 in one year is likely to put a taxpayer in the highest 37% tax bracket depending on their income. That would generate an estimated $232,708 tax bill on the converted amount.

Converting $75,000 a year could at least spread this charge out over several years. Converting at that rate is unlikely to completely drain the 401(k), however, because the funds in the tax-deferred account will continue to grow as the conversion process gradually moves them to the Roth account. For instance, assuming the tax-deferred investments earn a 7% average annual return, converting $75,000 annually for 13 years until RMDs begin at age 73 would leave approximately $180,738 in the account.

Converting larger amounts would increase the annual tax bill, while converting smaller amounts would mean leaving even more funds in the tax-deferred account, where they would be subject to RMDs. This may not be a bad thing, however. It often makes sense to have funds in both tax-deferred and after-tax accounts in retirement to allow for some flexibility in tax planning.

When a Roth Conversion May Not Make Sense

A Roth conversion is not always the best fit for every investor. Converting money from a traditional 401(k) or IRA increases your taxable income in the year the transfer takes place. For some people, this can lead to a much higher tax bill and possibly move them into a higher tax bracket. In such cases, the immediate cost of conversion can reduce or even cancel out the long-term benefit of tax-free withdrawals later.

Timing also matters. If you are close to retirement, you may not have sufficient time for the converted funds to grow enough to offset the taxes paid. The IRS also applies a separate five-year waiting period to each conversion, meaning you generally cannot take tax-free withdrawals from those converted funds until five years have passed. This rule can be an issue if you expect to need the money sooner.

A conversion can also influence other parts of your financial picture. The added income for that year might increase your Medicare premiums, affect the tax treatment of your Social Security benefits or reduce your ability to claim certain deductions and credits. These secondary effects should be weighed carefully before moving forward.

If you believe your income and tax rate will be lower after retirement, keeping your savings in a traditional tax-deferred account might be more efficient. Reviewing your income sources, spending needs and estate plans can help you decide whether a conversion makes sense. Because tax laws and personal situations differ, it may be useful to speak with a financial advisor or tax professional before making a final decision.

Bottom Line

Transferring tax-deferred retirement funds into an after-tax Roth account, can be an effective away to reduce or avoid having to pay RMDs. However, it’s far from a cost-free move. It can be tricky to balance the expenses against the gains in order to make an optimum decision about how and whether to proceed with a conversion. Key concerns include planned age at retirement and projected tax bracket after retirement.

Tax Planning Tips for Retirement

Consider meeting with a financial advisor to discuss plans for converting tax-deferred retirement account funds to a Roth account. 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.
You can get an idea right now of how much you’ll owe come next Tax Day with the help of SmartAsset’s Federal Income Tax Calculator.
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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