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Am I Too Old for an IRA Conversion?

Christine Benz

Christine Benz: Hi, I'm Christine Benz for Can you be too old to convert a traditional IRA to a Roth? Joining me to discuss that topic is Ed Slott. He is an IRA expert, and he is also author of the newly revised Retirement Decisions Guide. Ed, thank you so much for being here.

Ed Slott: Great to be back here at Morningstar, live in Chicago.

Benz: Exactly. Thank you so much, Ed. I sometimes get the comment from investors, am I too old to convert this traditional IRA to Roth IRA? I want to tackle that question. But before we get into that, let's talk about why one would even consider such a conversion. What are the benefits?

Slott: All right. First, the idea of a Roth conversion is, you are moving money from a taxable IRA or even a 401(k) to a tax-free Roth, and there's a cost to that. You pay tax on the taxable amount converted. It adds to your income. But the benefit is, once it's in a Roth IRA, in retirement, once you have five years and 59 1/2 years old, that money grows tax-free forever. It's withdrawn tax-free anytime you want. 

The biggest slip or benefit that most people don't even focus on is with Roth IRAs there are no required minimum distributions at 70 1/2 like you have for IRAs. Now, lots of people with IRAs don't like being forced to take distributions at 70 1/2, We talked about this before. They are forced to take money they don't need, add it to their income, raise their tax bill. With Roth, there are no lifetime required minimum distributions. That money can just grow. Remember, tax-free money always grows the fastest because it's not eroded by current or future taxes.When it come out, it's tax-free. In retirement, if you need it in retirement, it won't increase your tax bill.

Benz: There's this bit of received wisdom that people have heard that you can be too old to convert a traditional IRA to Roth. Do you think there's a kernel of truth there? Where is this coming from?

Slott: Well, there is something to that. You have to understand why you are converting. As a straight conversion, if you are, say, 70 1/2 or older--I just use 70 1/2 because that's the date for IRAs--but let's say you are around 70 or older, you are not doing it for yourself, because the cost--remember, there is a tax cost to converting. Given your life expectancy as you get older, say, after 70 1/2, the benefit you'll reap in your life expectancy won't be worth the upfront cost, probably. Unless you really have the other money sitting around and you just want to--I've had people say, look, I just can't stay in these RMDs. I'll pay the piper, pay the money. I'll never have to worry about it again. It's just off the table. Now, my money grows tax-free, and I've got plenty of money.

But the real benefit if you are doing it as an older person is for the next generation, for you children or grandchildren, because the power of the Roth IRA can grow over their life expectancy. Where a 70-year-old might only have a 13-, 14-year life expectancy or even longer maybe, but a grandchild maybe able to go out 60 years and the power of the Roth IRA is in the compounding tax-free. The big benefit is not so much for yourself other than those other issues--you just want to get rid of that IRA and not have any required distributions--but for your children or grandchildren who will also enjoy tax-free withdrawals. Now, with children and grandchildren, there are required minimum distributions when they inherit, but it's still tax-free.

Benz: You say that this is mainly something that one should consider if they are considering the next generation and wanting to pass on some tax-free assets to that generation. But can I infer from that that if I am someone who has looked at my IRA balance, my traditional IRA balance, and I think probably over my lifetime I'm going to consume everything in that IRA and perhaps I'm already retired, probably doesn't make sense for me to consider a conversion?

Slott: Right. Yeah, you hit it right on the head. It's more like an estate planning, legacy vehicle at that age. If you need the money or you'll consume it, chances are that you may even be in a lower tax bracket. Even with the new tax brackets now, you might be in a lower tax bracket, so it might pay to keep it.

Remember, the idea is to always pay taxes at the lowest rates. Maybe it doesn't pay to take a big hit in income if you are going to need that money right away. The benefit of the Roth is to keep it growing, compounding, tax-free over time. If you are going to pay a tax cost upfront just to take the money right out if you need it, that's not worth it.

Benz: I've sometimes heard that the years after one has retired but before those required minimum distributions have started, that that's a really opportune time to look at doing some conversions. Why would that be so?

Slott: I call that the sweet spot in your 60s. Why? Because many people, as I said, don't like the idea of looming required minimum distributions at 70 1/2. Some people in their 60s, maybe they just left the job, maybe they are retired, they are in a lower bracket, they can get that money in a Roth at a lower bracket. Now, everybody has to look at their own situation and see what the projected tax cost of a Roth conversion is. But you can lower the cost by doing a series of maybe smaller annual conversions. Remember, under the new tax law, all conversions now are permanent. You can't undo them.

Benz: The recharacterization is gone.

Slott: Right. That's gone. You could do a series of conversions, say, in your 60s with the ultimate goal of knocking down your IRA to nothing and building up your Roth IRA, so at 70 1/2 you don't have any required minimum distributions. It's all in a tax-free Roth.

Benz: How about after required minimum distributions have started? So, someone has passed age 70 1/2, are the conversions ever advisable at that life stage?

Slott: Well, again, you have to look at your own situation. Maybe you have big deductions or even big medical expenses, something that could really cut the cost. You are still in business, let's say, at 74 years old and you had a big loss, so you have to look at the tax situation. If you ever have a situation where income may be low because of high deductions, that may be the time to strike, to get that money in Roth at a very low tax cost. Or even if the stock market tanks--we've had these days where they go down 1,000 points--that may be the day to pounce when it's at a low value, you can get it into a Roth at a very low value. 

While generally in your lifetime being older, say 70 years old, it may not be worth it, if you can reduce, significantly reduce the tax cost through deductions or other factors like I mentioned, it might pay to get that money. What if you are in a real low tax bracket, it really doesn't cost you anything to convert, then you should probably do that.

Benz: Important topic. Lots of considerations. Thank you so much for being here, Ed.

Slott: Great to be here. Thanks, Christine.

Benz: Thanks for watching. I'm Christine Benz for