I’m 70 years old, have $1.5 million in a 401(k), and just started taking Social Security. Is it too late for a Roth conversion?

The problem with RMDs

The IRS offers tax breaks on traditional retirement plan contributions because it wants to help workers build a secure nest egg for their senior years. The IRS does not, however, want traditional 401(k)s and IRAs to become tools the wealthy use to pass assets onto their heirs, while enjoying tax breaks along the way. That’s why the IRS imposes RMDs.

The amount of your RMD each year will hinge on your savings balance and life expectancy. But you should know that RMDs count as taxable income. So if you don’t need the money, RMDs can be a huge pain.

However, blowing off your RMDs isn’t a good plan, either. You can be penalized with a 25% excise tax (though if you correct that mistake and take your RMD within two years, that penalty is reduced to 10%).

The nice thing about Roth 401(k)s is that they don’t impose RMDs for someone who will only reach 73 after 2024. So if you convert your traditional 401(k) to a Roth, you can get out of taking RMDs if you don’t want to worry about being taxed on those distributions every year starting at age 73.

Discover how a simple decision today could lead to an extra $1.3 million in retirement

Learn how you can set yourself up for a more prosperous future by exploring why so many people who work with financial advisors retire with more wealth.

Discover the full story and see how you could be on the path to an extra $1.3 million in retirement.

Read More

Tax implications of a Roth conversion

Before you move forward with a conversion, make sure to consider the tax hit you may be looking at. The money you convert from a traditional retirement account to a Roth account is treated as income. This could push you into a higher marginal tax bracket for the current year.

Also, if you're on Medicare, you may be subject to an income-related monthly adjustment amount (IRMAA) surcharge in two years if you have a very high income on file for the year you do your conversion.

Because $1.5 million is a lot of money, you may not want to convert that entire sum in a single year. That effectively pushes you into the highest marginal tax bracket.

If you're looking to avoid RMDs completely, you don't have much time between now and age 73 to convert your funds. But you may want to spread that conversion out over separate tax years. Depending on your total income, you may be taxed on your conversion at a more favorable rate.

Ultimately, your best move is to consult a tax professional if you're looking to convert a large amount of money into a Roth account. They can advise you of the best strategy, considering your total income picture.

A tax professional can also help you run the numbers to see if a Roth conversion makes sense at this stage of the game. Depending on your total income, it could make financial sense to keep your money in a traditional 401(k) and pay taxes on your RMDs at what could be a lower rate than what you’d be looking at by converting, even if you spread the conversion out.

Remember, too, that you don’t have to convert your entire 401(k) to a Roth. You may decide to convert a portion to exempt some of your assets from RMDs, but leave some where they are to minimize the near-term tax hit.