The Roth Conversion Strategy That Could Save You $21,000

There are plenty of reasons to consider a Roth conversion ahead of or in the early stages of retirement.

With a Roth conversion, you move money from a traditional IRA or 401(k) into a Roth IRA. The benefits include getting tax-free growth on your money, enjoying tax-free withdrawals, and not having to take required minimum distributions (RMDs).

But there’s a tradeoff.

When you do a Roth conversion, the money you move into a Roth IRA is taxed as ordinary income that year. And for this reason, it’s important to time a Roth conversion carefully. You don’t want to pay so much tax on the conversion that you negate its benefit.

With the right approach, however, you could save yourself a lot of money on a Roth conversion.

Timing and location matter

A strategic Roth conversion could result in big savings. That means not only choosing the right time to do your conversion, but also, the right location.

When you do a Roth conversion, you owe federal taxes on the money you move over. But you may not end up owing state taxes if you move to a state with no income tax.

Let’s say you’re 70 years old with a $250,000 balance in your traditional IRA, and you want to do a full Roth conversion over the next three years.

If your state tax rate is 8.4%, that conversion could cost you $21,000 in state taxes alone. If you move to a state without an income tax, you could whittle that $21,000 down to $0.

All you need to do is fully establish residency in your new state before doing that conversion. That way, your former state can’t try to go after those tax dollars.

Of course, it’s important to recognize that relocating in retirement isn’t necessarily an easy thing. It could mean leaving behind friends, family, and your community. But if you’re thinking about relocating anyway, you may want to favor a state with no income tax during your conversion years.

Make sure a Roth conversion is the right choice for you

A lot of people do Roth conversions because they want more freedom over their money. And that’s a good reason to look into one. But before you do a Roth conversion for the tax savings, you’ll need to make sure the numbers work in your favor.

For example, let’s say you have a $250,000 balance by the time you have to start RMDs. Your first year’s RMD may be as low as $9,434. The taxes on that could be minimal, as opposed to the taxes you might pay to convert $250,000 to a Roth IRA over a three-year period.

This is just one example. But the point is to realize that RMD taxes are not necessarily something to fear.

Of course, if you have a $3 million IRA, that’s a different story. But if your savings are more modest, a conversion may not pay after all.

Either way, if you do decide to do a conversion, you may want to consider relocating to a state without an income tax if that also meets your lifestyle needs. The savings could be substantial, depending on the state you’d be leaving behind.