I was forced into retirement two years ago. I am 64 and my wife is 60. My wife doesn’t work outside the home. We own our home, worth about $1 million, and have no recurring debt. We have enough money saved to live off for about three years. My total income from savings and investments was $25,000 last year. We have $1.3 million in an IRA and about $120,000 in a Roth IRA.
Two questions:
1) Should I wait to take Social Security (should be close to the top amount) and just live off IRAs after savings run out?
2) Does it make financial sense to do a massive roll-over of the IRA to a Roth IRA and pay the taxes now when my income is low? I had a guy run the numbers and it is mostly a wash. Is this really true?
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Dear reader,
You raise a number of very important decisions. Your letter also touches on the very delicate balance retirees must maintain among income streams.
There’s really no one right answer. Deciding when to claim Social Security is tricky. The choice relies on numerous factors, including life expectancy and health, but your income needs are major. First start by taking account of your cash flow, and all of your anticipated financial expenses for the next couple of years, and determine how much money you need each month to live. Consider everything, from taxes to doctor bills, trips to the movie theater to groceries, and so on.
Now for Social Security. If you turned 64 this year, and thus were born in 1959, your Full Retirement Age is 66 years and 10 months. (If you’re 64 going on 65 this year, your FRA is 66 years and 8 months).
Waiting until your full retirement age to claim has an inherent bonus — you’d get 100% of the benefit you’re owed, and your spouse would get 50% as spousal benefits. If you were born in 1959 and waited just until 65 to claim (specifically, the month you turned 65), you’d get 87.8% of the full benefit you’re owed and your wife would get 42.4% as the spousal benefit. The longer you wait after FRA to claim up until age 70, the larger your check would be.
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If you need that money now, or if you’re teetering on exhausting your savings in the name of getting more from Social Security, is it worth it to wait? A financial planner could help you run a few scenarios to break down your claiming options for Social Security mixed with a withdrawal rate that doesn’t deplete everything you have.
You might find you can wait two years to claim, so you’d get at least the full benefit you’re owed, and then you’d still have a year’s worth of savings outside of the retirement assets.
No one can predict the future, but we can plan for many, if not all, scenarios. For that reason, you never want to leave yourself without an emergency fund. Having liquid assets you can turn to in an immediate emergency is a blessing — not everyone has this choice. You shouldn’t aim to drain that money entirely.
As for your conversion question — knowing how to maximize the benefits of a Roth conversion is an “art and a science,” requiring creative planning and mathematical precision, said Lee McGowan, a certified financial planner and senior wealth adviser at Monument Wealth Advisors.
“It might make sense to roll 100%, but most likely an IRA owner would benefit from spreading the distributions over a period of years,” McGowan said. What’s more, a sizable rollover with a big tax bill could also lead to a higher Medicare premium, so consult a qualified tax professional before finalizing any transactions. (If you were on Social Security, the taxation associated with a rollover could affect that as well.)
What are your pre- and post-retirement tax brackets?
Would you stay in your current tax bracket post-conversion? That matters immensely, but it’s an unlikely outcome. “If a client can squeeze in every conversion amount in one year and stay in the same tax bracket, it’s no brainer to convert the entire amount in one year,” said Rose Swanger, a certified financial planner and principal of Advise Finance. “However, in reality, clients usually back out because of the amount of tax they have to pay.”
If you made $25,000 this year, as married individuals filing jointly, your tax bracket would be 12% under the 2023 tax brackets. Converting $1 million of your IRAs would push you into the 37% tax bracket. Converting $500,000 would push you into the 35% tax bracket. How comfortable are you with that? And where does that compare to your tax bracket prior to retiring? It’s obviously preferable to not go above your pre-retirement tax bracket.
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Also, you wouldn’t want to touch those Roth accounts right away. Roth IRAs have their own withdrawal rules. Also, allowing the account to grow untouched gives it a chance to recoup what it lost from paying taxes for the conversion, Swanger said.
Another possible headwind: under the Tax Cuts & Jobs Act, the existing tax rules are expected to sunset in 2025, at which point rates may increase. Don’t make decisions based on political matters, or events you can’t possibly predict, but it’s smart to be aware of these things.
You are exploring all potential outcomes and scenarios — and that is a good start.
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