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

Updated: 05-11-2024, 12.59 AM

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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.

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.

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.

While converting will avoid RMDs, it may not reduce the overall tax burden compared to not converting. For instance, a retiree may be in a lower tax bracket after retirement. If that happens, it may save money to leave the money in the tax-deferred account and pay the taxes on withdrawals after retirement. A financial advisor can help you weigh the tax bill tradeoffs in your situation.

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 that this is the right move before executing a conversion.

Gradually converting 401(k) funds to a Roth 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 complete 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 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. If you have questions about the best strategy for your retirement, consider using this free tool to match with a financial advisor.

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.

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 up to three financial advisors in your area, and you can interview your advisor matches at no cost to decide which one 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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