Are you 45 to 60 years old and either have a sizeable traditional IRA or have the opportunity to roll over a sizeable 401(k) plan or other retirement plan to an IRA? If so and you would like to enhance the likelihood of maximizing your retirement benefits, you should consider implementing a multi-year systematic plan to convert the vast majority, if not all, of your traditional IRA to a Roth IRA.
Ideally, you want to begin converting your traditional IRA to a Roth IRA beginning in 2010 and complete your conversion plan by the year that you will begin receiving Social Security benefits or no later than the year before you will turn 70-1/2. Your age, the value of your IRA, future contributions to your IRA, recharacterizations (See Recharacterization – Your Roth IRA Conversion Insurance Policy), income tax rates, income tax planning opportunities, and source of funds to pay the income tax liability attributable to your conversions will directly affect your actual annual conversion amounts as well as when you will complete your plan.
The last factor – source of funds to pay the income tax liability attributable to your conversions – needs to be carefully analyzed before you do a one-time conversion, let alone design a multi-year Roth IRA conversion plan. Per the January 25, 2010 post, Three Roth IRA Conversion “Show Stoppers,” if you don’t have sufficient funds in checking, savings, money market, and other nonretirement accounts outside of your IRA to pay the tax attributable to a Roth IRA conversion, you aren’t a good candidate for a Roth IRA conversion. The importance of this liquidity analysis is magnified in a multi-year plan.
Assuming that liquidity isn’t projected to be an issue and assuming there aren’t any other factors present that would negate the potential benefits to be derived from one or more Roth IRA conversions, there are five steps that should be included in a Roth IRA conversion plan for individuals who are 45 to 60 years old as follows:
- Begin your plan in 2010 using a larger planned conversion amount than in subsequent years.
- Skip 2011 and 2012 if you deferred the taxation of your 2010 Roth IRA conversion income.
- Convert an equal amount each year beginning in the year after the year(s) in which you recognize your 2010 conversion income.
- Complete your conversion plan by your Social Security benefit commencement date if it makes sense.
- Complete your conversion plan no later than the year before you turn 70-1/2.
Steps 1 and 2 will be addressed in Part 2 of this blog post, steps 3 and 4 will be discussed in Part 3, and step 5 will be presented in Part 4 together with a hypothetical case to illustrate the use of this strategy.
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.