A number of readers of this column have questions about required minimum distributions (RMDs). As a reminder, RMDs are withdrawals from tax-deferred retirement accounts such as traditional IRAs. They are mandated by the Internal Revenue Code when the owner of the IRA reaches age 72. Roth IRAs do not have RMD requirements for the owner. (Someone who inherits a tax-deferred or Roth IRA no matter what age is subject to RMDs.)
Since the questions have to do with transferring money to Roth IRAs, I’d like to review some Roth basics first.
Not everyone is eligible to contribute to a Roth IRA. If you have zero earned income, no luck. On the other hand, you can’t earn too much, either. For example, single filers whose MAGI (modified adjusted gross income) is $140,000 or more are locked out, as are married couples filing jointly with MAGI of $208,000 or more in 2021. You can look up 2021 annual contribution limits online at tinyurl.com/y44gem8w.
With this in mind, let’s answer a few questions, but be sure to check with your tax adviser before taking any action.
M.M. wants to know: “If a retiree has no earned income from a job, can that retiree withdraw funds from a traditional IRA and deposit them into an already established Roth IRA? Or into a new Roth IRA?”
ANSWER: Yes, you can, but you cannot use your RMD withdrawal to do that. The mechanism for moving money from a traditional IRA to a Roth is called a Roth “conversion.” When you withdraw money from the traditional IRA, that amount will be subject to taxes (above your IRA basis). Say your RMD is $10,000; if you withdraw only $10,000, there is nothing left to convert to a Roth. If you withdraw $15,000, you can convert $5,000. You’ll be taxed on $15,000.
The nice thing about a conversion is that there are no income caps. Anyone of any age and any income level can do a conversion.
B.S. shared: “Our financial situation is very modest. … What should I do with my RMD in 2021? We don’t need the money to live on as my wife is still working full time. … I want to save as much as I can now for when my wife retires in hopefully two years. … Can I put this money into a Roth IRA?”
Answer: No. As mentioned previously, you cannot use your RMD to convert to a Roth. But, you can use withdrawals above and beyond the RMD to convert. Again, those withdrawals will be taxable as income.
M.R. is under age 72 and feels that “(d)oing partial Roth conversions can be an effective way to reduce RMDs in the future, or eliminate them if possible, but many things need to be considered first, such as tax brackets now and once RMDs begin, where the money is coming from to pay the taxes on the Roth conversion, whether a person needs the Roth money to live on in retirement, their view on what future tax rates might look like, and using the Roth as a possible legacy.”
I agree.
M.R. wants to know if he should continue converting after he is 72 and taking RMDs. That, of course, depends on M.R.’s financial situation and goals. Again, M.R. would need to take the RMDs first. He would then take additional withdrawals to convert, after paying the taxes on both the RMD and the amount converted. Whether that’s a good idea will depend on goals and circumstances.
One thing for sure is this: I would rather have a tax-free Roth over a tax-deferred IRA any day. How to get there may or may not be worth the price — that will depend on your age, tax situation, legacy interests, cash flow, the size of your traditional IRA, and everything else that goes into planning for the future. It’s all about paying taxes today to be free of taxes in the future.
For further reading, refer to “Traditional and Roth IRAs,” an IRS publication, at tinyurl.com/y5un8ugh.
Julie Jason, JD, LLM, a personal money manager (Jackson, Grant of Stamford) and author, welcomes your questions/comments (readers@juliejason.com). Her awards include the 2020 Clarion Award, symbolizing excellence in clear, concise communications. Her latest book, a curated collection of Julie’s columns, is “Retire Securely: Insights on Money Management From an Award-Winning Financial Columnist.” To hear Julie speak, visit juliejason.com/events.