Should my parents convert 401k to avoid RMDs?

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Helping my parents out with their retirement finances: They have around $200k in a traditional retirement account. They have a pretty generous pension, which when combined a little income from a inherited (managed) rental, brings them into the low end (now) / middle end (after SS) of the 25% tax bracket and this will likely remain the case for life if tax laws/ brackets remain similar. So in regard to the traditional retirement funds, they'd pay marginal tax of 25% whether drawing/ converting $1 or $50,000 to Roth at current rates.

They live in small Midwest town with a paid off house and the pensions alone are probably twice what they spend. It is unlikely they'll ever need the money from the retirement account.

.1) Would it make sense to advise them convert to Roth as much as possible while staying in the 25% bracket to avoid the hassle of RMDs later in life? They could probably convert the entire thing in 4 or 5 years doing this.

2) Given that they don't/ won't need the money and don't have reason to believe their lives will be significantly longer or shorter than average, when should they start taking SS? Both spouses' earnings were similar. Currently 63/64 with neither spouse collecting.  

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You left out the possibility that each dollar converted causes their SS to be taxed at none, 50% or 85%. There is more than just the 25% bracket at stake here.

Rephrase your question taking those income points into consideration.

1) No reason to convert. They will likely remain in the 25% bracket forever. Its not as if taking the RMD poses any kind of work
2) Defer taking SS as late as possible

Chyvan said:   You left out the possibility that each dollar converted causes their SS to be taxed at none, 50% or 85%. There is more than just the 25% bracket at stake here.

Rephrase your question taking those income points into consideration.

  
That's a good point I hadn't thought of, but this says 85% taxable starts at income of $44,000, so they'll definitely be above that (pensions alone are  over $80,000).  

ETA: Not saying that Chyvan thought otherwise, but I was confused by it taking a tax class in college a decade ago and wanted to point out for innocent bystanders: 85% taxable means that 85% of SS is treated as taxable income at your marginal rate. It is not taxed at a rate of 85%. 

RMDs aren't a hassle at all.

I'd leave it as is. Their tax bracket isn't likely to change but if does it would most likely be for large medical related deductions that lower it. That would be a better time to take more than the RMD or do a conversion.

Three things:
1) They're in the same bracket whether you convert or not
2) They have large pensions and may never actually need the money, and may leave the bulk in retirement accounts and take only minimums (for a long time, at least)
3) You will not be in the same bracket when they die, adding 6 figures in taxable money which you'll be forced to take out and pay tax on

Because it makes no practical difference to them, and because they're mortal and these dollars may eventually be yours, and because it will almost certainly make a significant difference to your tax rate, you should certainly consider recommending converting, as the family's total tax will be lower. If they care, and think of finance as a team sport rather than an individual event, they might convert.

vranaco said:   85% taxable starts at income of $44,000,
  
You should play with some tax software on this. Could be that the standard deduction boosts that, and at 65 you get TWO deductions per person.

If your parents will be in the same tax bracket, converting now would allow additional growth on converted amounts to be free from tax. That's a win in my book. If they don't use up all their IRA money, then beneficiaries will receive a Roth inheritance tax free vs. receiving an inherited IRA where distributions are taxed at their rate. Another point for converting IMO.

As for SS, deferring until age 70, the breakeven is roughly age 84-87. Unless there are health issues, it's generally better to wait until age 70 if they can afford it.

mjohnson said:   receiving an inherited IRA where distributions are taxed at their rate. Another point for converting IMO.

Assuming the stretch survives, this is debateable. Every family has that very young member that doesn't have much promise of making more than minimum wage. That person won't be paying hardly any taxes, so rather than these people converting at 25%, they could give it to someone that will be paying 10%.
  

vranaco said:   
Chyvan said:   You left out the possibility that each dollar converted causes their SS to be taxed at none, 50% or 85%. There is more than just the 25% bracket at stake here.

Rephrase your question taking those income points into consideration.

  
That's a good point I hadn't thought of, but this says 85% taxable starts at income of $44,000, so they'll definitely be above that.  

ETA: Not saying that Chyvan thought otherwise, but I was confused by it taking a tax class in college a decade ago and wanted to point out for innocent bystanders: 85% taxable means that 85% of SS is treated as taxable income at your marginal rate. It is not taxed at a rate of 85%. 

  
There is a calculator here that can give you an idea how much an IRA distribution (i.e. Roth conversion) will impact the taxes.
http://www.calcxml.com/calculators/how-much-of-my-social-securit... 

As somebody already mentioned, Roth IRA conversion is worth considering if you parents don't plan to spend it.  There are no RMDs for Roth IRA (yet), although the law makers keep talking about changing this rule. So, it can sit and grow tax free.  If you end up inheriting a Roth IRA, you won't have to pay taxes on the distributions.  It may actually be a good idea to do as much conversion as possible before they start taking SS to minimize the tax hit on the SS income.  If they don't convert, the RMDs during those years will be pushing their income up.  But the conversions are constrained by the tax brackets, of course.  So, some quality time with Excel is probably a good idea....

What are your parents' ages? When they reach age 70, They will then be barred from Roth Conversions. That is my current problem.  The past few years, I have been taking some Roth Conversions out of my IRAs to spread out the tax impact instead of all in one year.

Minimum Required Distributions (MRDs) information:
https://www.fidelity.com/retirement-planning/learn-about-iras/minimum-required-distributions/overview

JW10 said:   What are your parents' ages? When they reach age 70, They will then be barred from Roth Conversions. That is my current problem.  The past few years, I have been taking some Roth Conversions out of my IRAs to spread out the tax impact instead of all in one year.

Minimum Required Distributions (MRDs) information:
https://www.fidelity.com/retirement-planning/learn-about-iras/minimum-required-distributions/overview

Your RMD can't be a Roth Conversion, but you can do a Roth conversion on top your RMD. 

JW10 said:   What are your parents' ages? When they reach age 70, They will then be barred from Roth Conversions. That is my current problem.  The past few years, I have been taking some Roth Conversions out of my IRAs to spread out the tax impact instead of all in one year.

Minimum Required Distributions (MRDs) information:
https://www.fidelity.com/retirement-planning/learn-about-iras/minimum-required-distributions/overview

  You're not "Barred" from doing Roth Conversions but you are required to take your RMD before you convert any funds.
    https://www.irahelp.com/slottreport/4-steps-taking-roth-conversi...
    http://www.marketwatch.com/story/roth-ira-conversions-what-advis...

Probably the only real possibility that they have is doing some conversions before they get into Social Security. It may not amount to much if they keep it low enough to not be a detriment to their taxes. Anyhow, others are right... if this is how taxes will remain, maybe there isn't a lot that can be done other than take a big hit one year (convert, withdraw, etc), then keep it minimized the next (do as minimal as can be done). Is there any way for them to withdraw the funds for one year in a different calendar year for RMD? Like, previous year in Jan-Apr? Let's say they did this now... took 2016 withdraws this month... but they would count against 2017 taxes (I am not that well versed on these things as I don't know anyone well enough that has money to deal with in retirement)? Then you stack it all into one year... if you are going to get hit hard... take two years in one if the detriment is linear... then the other year, keep from getting pummeled.

Dus10 said:   Probably the only real possibility that they have is doing some conversions before they get into Social Security. It may not amount to much if they keep it low enough to not be a detriment to their taxes. Anyhow, others are right... if this is how taxes will remain, maybe there isn't a lot that can be done other than take a big hit one year (convert, withdraw, etc), then keep it minimized the next (do as minimal as can be done). Is there any way for them to withdraw the funds for one year in a different calendar year for RMD? Like, previous year in Jan-Apr? Let's say they did this now... took 2016 withdraws this month... but they would count against 2017 taxes (I am not that well versed on these things as I don't know anyone well enough that has money to deal with in retirement)? Then you stack it all into one year... if you are going to get hit hard... take two years in one if the detriment is linear... then the other year, keep from getting pummeled.
  No

Chyvan said:   
vranaco said:   85% taxable starts at income of $44,000,
  
You should play with some tax software on this. Could be that the standard deduction boosts that, and at 65 you get TWO deductions per person.

  Please correct me if I am wrong but I believe the standard deduction for over 65 only increases by $1250 per person if married and  $1550 if single.

Dus10 said:   Probably the only real possibility that they have is doing some conversions before they get into Social Security. It may not amount to much if they keep it low enough to not be a detriment to their taxes. Anyhow, others are right... if this is how taxes will remain, maybe there isn't a lot that can be done other than take a big hit one year (convert, withdraw, etc), then keep it minimized the next (do as minimal as can be done). Is there any way for them to withdraw the funds for one year in a different calendar year for RMD? Like, previous year in Jan-Apr? Let's say they did this now... took 2016 withdraws this month... but they would count against 2017 taxes (I am not that well versed on these things as I don't know anyone well enough that has money to deal with in retirement)? Then you stack it all into one year... if you are going to get hit hard... take two years in one if the detriment is linear... then the other year, keep from getting pummeled.  

Before making any drastic decisions, I would also wait to see what comes from this year in tax-code related changes. Sounds like tax brackets are going to drastically change at some point this year. At the very least, see if it would be more beneficial to keep it pre-tax after we see the changes announced.



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