- While rolling over funds can translate into tax-free income available down the road, you also pay taxes on the amount moved — which means no future opportunity to reduce that rate further.
- Medical expenses, which often are higher among retirees, can be taken as an itemized deduction if you have taxable income to count it against.
- If you regularly give money to charity, so-called qualified charitable distributions sent directly to the charity from a traditional IRA — are excluded from your taxable income.
If you're planning to roll over all your assets from a traditional individual retirement account to a Roth version, you might want to tap the brakes.
While Roth IRAs grow tax-free and withdrawals generally also are untaxed — and they come with no lifetime required minimum distributions, or RMDs — traditional IRAs have some potential tax benefits that are lost for future use once the money is moved.
"The whole idea behind managing taxes in retirement is that you want to get as much money out of your accounts at the lowest possible cost," said Ed Slott, CPA and founder of Ed Slott and Co. in Rockville Centre, New York.
"I'm a big Roth fan, but if you can get your taxes lower, you may want to hold back some of your money in the traditional IRA," Slott said.
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Those tax benefits generally relate to medical expenses, charitable contributions and business losses (explained further below).
When you roll over money from a traditional IRA to its Roth counterpart, the amount moved is taxed as ordinary income. Because of that, financial advisors generally recommend that the rollover is done when you're in as low a tax bracket as possible.
While the strategy translates into tax-free income available down the road, it also means you will have already paid taxes on the rollover, so there's no opportunity to reduce the rate further. On the other hand, if you leave too much in the IRA, the result may not be in your favor (i.e., higher RMDs and taxes).
"If you think that you could have these future expenses, then sure, it might make you want to keep money in the traditional IRA," said CPA Jeffrey Levine, CEO of BluePrint Wealth Alliance in Garden City, New York. "But it needs to be driven by your personal circumstances and situation."
Health costs tend to be a major expense for older Americans — to the tune of about $285,000 over an average couple's retirement, according to Fidelity Investments. That doesn't include the cost of long-term care — help with daily living activities like eating and dressing — which about two-thirds of 65-year-olds can expect to face at some point over the rest of their lives, according to government estimates. And generally speaking, those costs aren't covered by Medicare.
At the same time, a tax break for medical expenses is one of the few remaining deductions available to individuals since the new tax law took effect in 2018. While it's limited to the amount that exceeds 10% of your adjusted gross income and you must itemize your deductions to take advantage of it, people with high medical bills can potentially reduce their tax bill by using it.
But to take the deduction, you must have taxable income to weigh it against — which means that if much of your income is tax-free due to it coming from a Roth IRA, you could be limited in whether you can take advantage of the break.
On the other hand, if you took money from an IRA — whose withdrawals are taxed as ordinary income — to cover those health costs, you could use the medical deduction against that withdrawal. That could mean paying less in taxes than what you had paid by rolling that money to a Roth.
"It's not unusual these days to see someone claiming $100,000 in medical expenses," Slott said.
If you give money to charity each year, keeping money in your traditional IRA to make those donations could make sense.
Contributions made through so-called qualified charitable distributions — funds sent directly to the charity from a traditional IRA — are excluded from your taxable income.
In contrast, the tax break for charitable contributions — like the break for medical expenses — can only be used if you itemize your deductions. And, generally speaking, a deduction is not as valuable as an income exclusion.
This strategy, though, is only available to IRA owners and beneficiaries who are 70½ or older. Yet because that's the age when RMDs kick in, the move could potentially reduce your tax liability on the RMD to zero.
"If your RMD is $5,000, but you give $5,000 to charity anyway, do the qualified charitable distribution and you don't have to pick up any of the income," Slott said.
As is the case with the deduction for medical expenses, business losses can only be claimed on your tax return if you have income to claim them against.
So if you've moved all of your traditional IRA funds to a Roth, and your business has a bad year or two, those losses would not be deductible against Roth withdrawals.
The way the U.S. tax system works is that regardless of your overall income, any amount that falls into each of seven defined brackets is taxed at a specific rate.
In other words, whether someone has income of $20,000 or $2 million, the lowest rate — 10% — applies to a certain amount of that income (zero to $19,400 for a married couple and up to $9,700 for a singles). The next-lowest rate (12%) applies to another range of income, and so on — with the top rate of 37% applying to income above $612,351 for married couples and $510,301 for singles.
So, the more income you can get taxed at those lower rates, the better, Slott said.
Say you are able to convert your traditional IRA assets to a Roth at 24%.
"If you were to leave some money in the IRA to soak up some of those lower tax rates in future years, you may pay less in taxes on the money than if you converted it," Slott said.
Be aware, however, that the current tax brackets and rates are set to revert back to pre-2018 levels at the end of 2025 unless Congress takes action before then. In other words, while tax rates are low now, there's a good chance they'll be higher down the road.
"The way to get the most out of your money is to pay as little in taxes as possible," Slott said. "It's important all the time, but especially in retirement."