Just when you think you’ve got your finances figured out, a new twist appears: the Roth IRA conversion.
Until recently I thought I understood Roth IRAs pretty well. A few years ago I cautiously converted a small amount (under $50K) from a Traditional IRA to a Roth. This post is for anyone who has a large 401(k) balance and is planning for long-term retirement.
Why does a Roth conversion matter for someone retiring in their 40s or 50s? It comes down to taxes. Current rules for Gen X and younger retirees require minimum distributions (RMDs) starting at age 75. So if you retire now at 50 with about $1.5M in your 401(k), assuming a 7% growth rate, you’d face a required distribution of roughly $270K at 75, rising to about $350K by age 80. Those are big withdrawals — and big tax bills.
If you plan to spend that much in your late 70s and 80s, fine. But remember you’ll likely also be receiving Social Security by then, which can push you into a much higher tax bracket and leave you praying for a tax miracle.
What can an early retiree do? Many of us saved aggressively and cut expenses to reach this point. We may have some rental property, a brokerage account, and an HSA. Can’t we just leave the pre-tax 401(k) alone and pay taxes when RMDs start? You can, but that’s a gamble that tax rates or brackets won’t rise. A projected federal tax bill of over $100K a year could convince you to act sooner.
I’ve been retired a couple of years, and only recently dug into post-retirement taxes and distributions. I watched several CFPs on YouTube flashing big warning numbers — your retirement savings could get hit hard! Their common fix is the Roth conversion. How does it work? There are basic steps, but do your homework and go in with open eyes.
This is the million-dollar question: when and how much to convert. Thankfully there are simulation tools to help. After seeing many CFPs use fancy graphs, I looked for tools regular people can use. I settled on Planner Plus at Boldin.com. Unlimited access is $120 a year — a small price for a powerful toolkit. You can link your accounts for live updates, but I entered our data manually to reduce the risk of exposing personal information.
I’ve only scratched the surface of Planner Plus. Right away it gives an assessment of whether you’re on track to retire with enough assets.
Before using the Roth Conversion Optimizer, a few other features stood out. If you can peel yourself away from What Ifs, Insights, Coaching, and more, the Roth Conversion Optimizer is worth a look — it really works.
Here are the parameters I used for our situation, and in seconds the simulation produced clear results. There’s a lot to unpack, and Planner Plus supplies a ton of data. Boldin also offers paid coaching if you want help interpreting the results. I haven’t used the coaching yet, but I plan to. After a month with Planner Plus, I feel like a kid in a candy store. For financial geeks, it’s a deep time sink that can pay off quickly.
The tool is flexible: you can change variables to run different scenarios based on inflation, cost of living, interest rates, and investment growth.
Subscribers also get many resources, including live and recorded classes. One of the best tools is the scenario comparison feature. After running a couple of scenarios, you can compare metrics like lifetime tax obligations and net worth based on different variables and Roth conversion schedules. It sounds complicated but is easy to use.
I already had my annual meeting with our tax accountant before signing up for Boldin. He suggested converting each year’s growth in our pre-tax 401(k)/IRA up to the 22% tax bracket, and continuing that strategy nearly every year until about age 80. Our accountant gives solid advice, though it’s based on experience and not a detailed model. I’m a DIY person, so Planner Plus’s numbers were a helpful confirmation and gave me specific targets to plan around.
You have to keep learning about taxes and retirement planning, or it can bite you later. The IRS is unforgiving.
I can’t say exactly why I dove into Roth conversions, but I’m glad I did and glad to have Planner Plus as a resource.
A few parting tips: if you’re in your 20s or 30s and your employer offers a Roth 401(k), consider using it — it’s becoming more common and can save you money later when RMDs kick in. If you start earning well into six figures, talk to your accountant about a target tax bracket. Ideally you’ll balance taxes during your working years and in retirement.
If you want a book that will motivate you to act, read The Retirement Savings Time Bomb Ticks Louder… by Ed Slott. It’s full of eye-openers for those who aren’t prepared.
Featured Photo by The New York Public Library on Unsplash