Dear Liz: My husband and I both waited until age 70 to start Social Security. I will be 72 in September and am considering retirement. My husband is retired, 74, and taking required minimum distributions (RMDs). We have always tried to maximize contributions to our pre-tax retirement accounts and are now realizing the downside as we pay taxes on those mandatory withdrawals. Should I consider Roth conversions now or after I retire? I realize I will need to pay taxes on those conversions, but would it be best to do that when my income is lower? I am thinking about my kids and their future.
Answer: Late-in-life Roth conversions can be tricky. The amount you convert is removed from RMD calculations, lowering future tax bills. But the conversion is added to your current taxable income, potentially making more of your Social Security taxable and temporarily raising your Medicare premiums (thanks to income-related monthly adjustment amounts or IRMAA) in addition to generating a big tax bill.
Theoretically, a conversion could still make sense if your current tax rate is lower than the one you’ll have once you start required minimum distributions at 73. The case for conversion is strengthened if you want to pass this money to your kids. They likely would have to empty any inherited retirement account within 10 years, and they could be in their peak earning (and tax-paying) years when they do so. By converting now, you would in effect be paying the tax bill for them, perhaps at a lower rate than they might face, and allowing them to inherit the money tax-free.
A tax pro can help you with the calculations so you’ll understand the financial impact of a conversion. Then you can make an informed decision about whether to proceed.
Dear Liz: Your recent column about how to distribute estimated tax payments over the year (equal versus backend loaded) may have missed an important nuance. Your answer regarding the Form 2220 safe harbor is correct and would apply if the taxpayer’s income were retirement fund distributions. As I read the query, however, it’s possible (perhaps likely?) that the yea-rend distributions are from a taxable brokerage account. In that case, even absent intra-year distributions to the taxpayer, the dividends appearing in the TP’s account are deemed constructively received when paid by the portfolio companies into the brokerage account.
I can understand how an IRS agent would simply argue for equal payments. And I similarly understand that a competent accountant would know the safe harbor rules. It’s impossible to know which of them is correct here from the letter as printed.
Answer: My answer relied on guidance from Mark Luscombe, principal analyst for Wolters Kluwer Tax & Accounting, and he says that you have a point.
The original writer stated that they received the majority of their income at the end of the year, and most of it was dividends from their brokerage account. The writer had been told by an IRS agent that estimated tax payments were due throughout the year, while the writer’s accountant contended that wasn’t necessary. The writer didn’t specify whether it was a taxable or retirement account or when the dividends were actually paid into the account.
Luscombe assumed that the dividends were received at the end of the year, but the writer could have meant that dividends were only withdrawn then.
If the account is a qualified retirement brokerage account, it wouldn’t matter when the dividends were paid, only when the withdrawal was made, Luscombe notes. If it’s a taxable account receiving dividends throughout the year, then the IRS agent would be correct that the dividends would be taxable based on when they were received into the account.
Liz Weston, Certified Financial Planner, is a personal finance columnist. Questions may be sent to her at 3940 Laurel Canyon, No. 238, Studio City, CA 91604, or by using the “Contact” form at asklizweston.com.
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