I'm 58 years old and have $1.7 million in my 401(k). Should I start converting 10% of my funds each year to a Roth IRA immediately to avoid RMDs and taxes?

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Moving retirement savings from a 401(k) or similar tax-deferred account to a Roth IRA can help you avoid having to make taxable withdrawals in your 70s. This can reduce your tax burden in retirement but may not necessarily result in overall tax savings. That's because any funds converted to a Roth will be taxed as ordinary income at your current tax rate, which could result in a hefty tax bill the next time you file.

A conversion may still make sense if you expect to be in a higher tax bracket after retirement and reach the mandatory withdrawal age, have no need for RMD funds, wish to preserve wealth for your heirs, or in other circumstances. But the most effective conversion strategy may not be based on converting a certain percentage of your 401(k) every year. Instead, you're probably better off calculating the conversion amount based on the impact on your tax bracket.

A financial advisor can help you evaluate the pros and cons of a Roth conversion strategy. Get matched now with this free tool.

If you are 58 years old and have your retirement savings in a 401(k) plan, you must take a predetermined minimum distribution (RMD) each year starting at age 75. These withdrawals will be considered taxable income, and the resulting tax bill will reduce the income you have available to pay for retirement living expenses.

You can move funds from tax-deferred to tax-free by rolling them from a 401(k), IRA, or other tax-deferred retirement savings account into a Roth IRA. Once deposited into a Roth account, the funds are not subject to RMD rules, so you don't have to worry about having to withdraw funds you don't need for living expenses.

If you do need money saved for retirement, you can withdraw it from a Roth account without paying any taxes or penalties. The only restriction here is that if you convert before age 59 1/2, you must wait at least five years after the conversion before taking any withdrawals.

However, a Roth conversion comes at a cost, as the converted amount will be treated as ordinary income on your current tax return. Therefore, converting a large 401(k) can result in a large tax bill in the short term. With this in mind, many people who convert choose to do it gradually, converting a portion of their 401(k) over several years to spread out the taxes and prevent themselves from slipping into a higher tax bracket, where your money will be Charge higher fees. rates.

The decision to convert your 401(k) to a Roth, and the amount of the conversion, depends on several interdependent factors, including your current income and expected taxable income in retirement. It's also worth remembering the fact that Roth withdrawals are not considered when determining income levels that affect Social Security benefit taxes and Medicare premiums.

Remember, a financial advisor can help you identify and implement an appropriate strategy based on your situation.

If you are a relatively high earner with $100,000 in taxable income, you may be in the 22% marginal income tax bracket and pay $13,841 in federal income taxes on your 2024 tax return. Converting 10% of your $1.7 million 401(k) would add $170,000 to your current taxable income. As a single filer, the resulting $270,000 in income would put you in the 35% tax bracket and result in a federal tax bill of approximately $59,754 for the year.

Conversely, if you follow a strategy of only redeeming enough to move you to the top of the next highest tier, you can redeem $91,950. This would keep you within the 24% range and result in a current tax bill of $35,606.

None of these gradual conversion strategies will completely wipe out your 401(k) after 17 years, when you turn 75 and are required to contribute RMDs. So you'll still need to take some taxable forced withdrawals, or you may have to bite the bullet and incur a higher tax rate to convert your entire 401(k) in time. Ultimately, there are a lot of dynamics that come into play with your income and taxes over time. But given the difficulty of predicting future income tax rates and your own income, it makes sense to have funds in a 401(k) and Roth to give you flexibility.

Consider speaking with a financial advisor to further explore the trade-offs of a Roth conversion based on your situation and goals.

Converting funds from a 401(k) to a Roth IRA can help you avoid RMDs and future taxes. However, converting today will cost you in the form of additional income taxes. You may still want to make the conversion, especially if you think you'll be in a higher tax bracket in retirement. However, a conversion strategy based on converting just enough money to move your income into your current or next highest tax bracket may make more sense than converting a set percentage each year.

Image source: ©iStock.com/Abdullah Durmaz

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