Here’s how to maximize those retirement ‘sweet spot’ years
BY: Sarah O’Brien
April 5, 2018
As you head into retirement, there’s a chance you also are entering a special time to do some serious tax planning.
This sweet spot is the stretch of time between when you retire from full-time work and when you have to start taking required minimum distributions from your 401(k) plan or your traditional individual retirement account at age 70½.
Presumably, given that full-time work is behind you and those mandated distributions are ahead of you, it’s also when you find yourself in a lower tax bracket.
“This is a good time to look at whether some strategies can work that help with taxes,” said Avani Ramnani, director of financial planning and wealth management at Francis Financial.
While there are ways to take advantage of lower tax rates, it’s important to make sure any moves you make are in line with your broader retirement goals.
“Minimizing taxes should not dictate all financial decisions,” Ramnani said. “Ultimately, it is about using the best approach to be able to achieve [your] most important life goals.”
Here are some ways you might be able to capitalize on your lower tax bracket.
It could make sense to convert a traditional IRA or a 401(k) plan account to a Roth IRA.
While you must pay income taxes on the amount converted, it would be at your temporarily lower rate.
In comparison, if you were to leave those assets in a traditional IRA or 401(k) plan and not touch them until you begin taking required minimum distributions, those withdrawals could push you into a higher tax bracket. As such, a higher tax rate would apply to the assets.
In contrast, withdrawals from Roth IRAs are generally tax-free. There also are no required minimum distributions that come with them. In fact, some people simply let the balances accumulate over their lifetime and pass the Roth IRA on to heirs (who also enjoy the tax-free status, although they must meet other rules).
You also can stretch a conversion to a Roth IRA over several years, which can minimize the tax sting and can help ensure the switch doesn’t push you into a higher tax bracket in any given year.
However, before you get the wheels rolling, there are some aspects of the conversion to consider.
For starters, you need to make sure you have enough cash available to pay the taxes due.
Also, new tax rules that took effect this year eliminate the option to change your mind for conversion done in 2018 or later.
“If you do the conversion, you’re locked in,” Ramnani said.
Additionally, the Roth IRA generally must remain untapped for at least five years after the conversion for you to take advantage of completely tax-free withdrawals.