The 45 to 60 5-Step Roth IRA Conversion Strategy – Part 3

As a general rule, if possible, you should plan on completing your Roth IRA conversion by the date when you will begin receiving Social Security benefits.

Part 1 of this blog post introduced a 5-step Roth IRA conversion strategy for individuals 45 to 60 years old who either own a sizeable traditional IRA or have the opportunity to roll over a sizeable 401(k) plan or other retirement plan to an IRA. Last week’s post presented steps 1 and 2 of this strategy. This week’s post discusses steps 3 and 4. Step 5 will be presented in Part 4 together with a hypothetical case to illustrate the use of this strategy. If you haven’t done so already, I would recommend reading Part 2 to learn about steps 1 and 2.

Step 3 – Convert An Equal Amount Each Year Beginning in the Year After the Year(s) in Which You Recognize Your 2010 Conversion Income

If you deferred the taxation of your 2010 Roth IRA conversion income, you should plan on converting an equal amount of your traditional IRA to a Roth IRA each year from 2013 until you complete your Roth IRA conversion strategy in order to keep things simple and increase the likelihood of sticking with your plan. Alternatively, if you recognized your 2010 Roth IRA conversion income on your 2010 income tax returns, you should begin your “equalization” phase in 2011.

Depending upon income tax rates and your particular situation, there may be years when you will want to increase or decrease your conversion amount in order to minimize your income tax liability. To the extent that you do this, you will need to adjust your annual equalization amount going forward. You will also need to adjust your future annual equalization amounts for any additional contributions or rollovers to your traditional IRA as well as for any recharacterizations (See Recharacterization – Your Roth IRA Conversion Insurance Policy).

Step 4 – Complete Your Conversion Plan by Your Social Security Benefit Commencement Date If It Makes Sense

As a general rule, if possible, you should plan on completing your Roth IRA conversions by the date when you will begin receiving Social Security benefits. This will be much easier to accomplish if you begin your conversion plan between age 45 and 50 assuming that your traditional IRA is not increased by any sizeable contributions and/or rollovers after age 50.

Given the overriding goal of reducing the taxation of Social Security benefits and the fact that Social Security benefit taxation is directly influenced by the amount of your other taxable income, the absence of Roth IRA conversion income could reduce, or potentially eliminate, otherwise taxable Social Security benefits under current income tax laws.

Assuming your other income is projected to be sufficient to cover your expenses, it may even be advisable to defer your Social Security benefit commencement date so that you may extend your conversion period and, in turn, minimize your Roth IRA conversion income tax liability.

In addition, since the Medicare Part B, or medical insurance, premium amount is determined by one’s income, the absence of Roth IRA conversion income beginning at age 65 could help keep Medicare Part B premiums in check.

Depending upon your current age, it may not be prudent to complete your Roth IRA conversions by your Social Security benefit commencement date since doing so may require you to incur a substantial amount of income tax liability in connection with your Roth IRA conversion amounts. This is especially true if you’re 60 or older when you begin your conversion plan, you have a sizeable traditional IRA, and you aren’t planning on doing any conversions in 2011 and 2012 (see Step 2 in Part 2). In addition, if it is projected that you will have a substantial amount of income from other sources that is projected to result in taxation of your Social Security benefits, it probably won’t make sense in most cases to accelerate your Roth IRA conversion plan so that it is completed by your Social Security benefit commencement date.

For the fifth and final step of the 45 to 60 Roth IRA conversion strategy, watch for Part 4 next week.

By Robert Klein

Robert Klein, CPA, PFS, CFP®, RICP®, CLTC® is the founder and president of Retirement Income Center in Newport Beach, California. Bob is also the sole proprietor of Robert Klein, CPA. Bob applies his unique background, experience, expertise, and specialization in tax-sensitive retirement income planning strategies to optimize the longevity of his clients’ after-tax retirement income and assets. He does this as an independent financial advisor using customized holistic planning solutions based on each client’s needs and personality.