Near Retirement, Convert IRA to Roth or not if changing state residence

Submitted by Kay Carter on Thu, 2018-01-25 14:13

Most of savings in traditional IRA. Seems prudent to make rollover to Roth IRAs in years leading up to RMDs, Presently live in state with tax burden of little more than 4%, which fully taxes retirement benefits. Contemplating move in future to state that does not tax retirement benefits. If make rollovers to Roth now, would be paying tax on distributions that would not be taxed if moved to other state. Would it still be worth it? What calculations would be pertinent? Expected return, years before withdrawal?



Submitted by Alan - IRA critic on Thu, 2018-01-25 16:11

The main driver of conversion analysis is a comparison of the total tax rate paid for the conversion with the estimated marginal rate you would owe in retirement on the TIRA RMDs and other distributions if you didn’t convert. You would total the federal and state marginal rates in this comparison. You would also translate such things as IRMAA surcharges into your marginal rate in retirement. A move to a state that does not tax retirement income would lower your rate in retirement, making it less likely that conversion would be beneficial. Of course, the state income tax rates are only one factor. Determining the cost to convert is easy, but estimating your marginal rate in retirement is a crap shoot because many things can change in the interim including your personal financial situation. Note that if you delay SS benefits, it can provide more years of very low tax rates in which to convert. The recent tax bill lowers rates for 8 years, but what happens after that is anyone’s guess.

Submitted by Kay Carter on Thu, 2018-01-25 16:53

I am assuming our tax rate will be very similar before and after retirement. Have been in 15% range, now 12%. Expect to be in that range in retirement, or whatever bracket replaces the 12% in the future.  If we remain in the same state, it seems to be a wash as to whether to convert.  I like the idea of not having to calculate and withdraw RMDs in a Roth.  It seems easier to invest where you can leave assets in whatever investments you choose rather than withdrawing RMDs if you do not need full amount and then having to invest in a taxable account.  However, this simplicity alone would not drive me to make the conversions if I am going to end up pay state tax that I would not otherwise have to pay.  The only way the conversion seems to make sense in this scenario is if we leave the Roth money alone as the last account touched, using RMDs from traditional accounts and SS in earlier retirement years. I was wondering how many years it would take to make a Roth conversion practical in terms of long-term growth. Of course, what return on investment to expect in coming years is anyone’s guess.

Submitted by Alan - IRA critic on Thu, 2018-01-25 17:39

Roth money is usually distributed last, or perhaps sooner in a high expense year to avoid having to take more taxable distributions from the TIRA. The Roth is also marginally less valuable if you do not have LTC insurance, where higher taxable TIRA distributions would be offset by the medical deduction. If you are on the fence regarding conversions, then look at tax diversification. If you have a very small Roth, that would justify increasing it and reducing the TIRA somewhat, but not so much if your Roth is already relatively large. Situations like yours require revisiting this decision annually rather than setting a long term plan in motion without observing changes in their scenario. One of the major life event changes is death of a spouse where the survivor inherits these accounts and income drops only a little, but the taxes go up considerably filing single.

Submitted by David Mertz on Thu, 2018-01-25 17:51

  • The potential for tax free growth of the money in a Roth IRA will often be greater than a few percentage points of additional marginal tax rate that you pay now as long as you pay the taxes on the conversion with other funds and, as you said, the money can remain in the Roth IRA for a long time after the conversion, while you deplete other assets first.
  • As you also said, the amount of time needed to make up the difference depends on the average rate of return on the investments.  In my own case, recent stock market performance has resulted in reaching break-even in only a few years on an extra 3% tax paid (over my anticipated retirement marginal tax rate) to do some of the earlier conversions.  But it’s hard to model, given all of the variables.  I also anticipate that some remaining balance in my Roth IRAs will be going to non-spouse beneficiaries who will stretch the distributions over their life expectancies.
  • Also, if you anticipate your estate being large enough be subject to federal estate tax (or state estate or inheritance taxes, but probably not in a state that has no income tax), the Roth conversions will reduce your gross estate.  Of course if your estate is subject to federal estate tax your beneficiaries will be able to take an IRD deduction for distributions from the traditional accounts up to the amount of estate taxes paid, so the benefit of reducing size of your gross estate may not be that great.  It depends to some extent on the anticipated marginal tax rates of your beneficiaries.

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