Tax Effective Transitions to Roth IRAs

Most people in or near retirement don’t have a clue regarding their effective tax bracket and what “head room” remains for tax conversion strategies without “bracket bumping.” Headroom is the annual amount available to convert qualified plans monies to tax free monies. The goal is not to convert an amount that would bump the taxpayer into a higher tax bracket. Ideally, people should consider qualified plan conversion right after age 59½ and continue the conversion process up to age 70½. The goal is to pay taxes before retirement and fund Roth IRAs and Cash Value Life Insurance. Both have the potential to generate tax-free income that will not be includable in the provisional income test for Social Security Benefits.

The taxes on any unconverted qualified plan monies at age 70½ can be mitigated by using QLACs, Stretch IRAs and Qualified Charitable Distributions. The name of the game here is to lower RMDs (required minimum distributions). QLACs are Qualified Longevity Annuity Contracts that allow an individual to postpone 25% of their qualified plan monies, not to exceed $125,000, to age 85 using a deferred income annuity. By deferring qualified monies to age 70½ and age 85, you can lower your RMDs. Stretch IRAs can reduce RMDs by beneficiary reassignments, generally spousal or children, that are predicated on the younger of the two. Gifting to adult children can stretch the income over the life of the younger beneficiary, thus reducing the RMD obligation. Qualified Charitable Distributions now go direct from the IRA to the IRS-approved charity up to $100,000 a year per individual.

These three post 70½ strategies can impact Social Security benefit taxation by lowering the income includable in the provisional income test, sometimes lowering the threshold a full “tier.” (There are two taxation tiers that are used to measure how much income is exposed to taxation.) Tax planning can have a significant impact on retirement cash flow and should be a major consideration in designing your retirement plan.