Conventional wisdom regarding Traditional IRA’s is to not take distributions from your Traditional IRA because you will have to pay tax on it. Let the assets in your Traditional IRA continue to grow tax deferred and take distributions based on the IRS Required Minimum Distribution rules (RMD’S). Another strategy is to convert your Traditional IRA to a Roth IRA. This is a hot topic and there is a lot of information today from advisors and the internet in relation to a Roth conversion.
There are many good reasons to make a Roth conversion. Those reasons include:
- Minimizing income tax
- Possible lower tax brackets in the future
- No Required Minimum Distributions
- Tax-free growth
This article will come at it from a different angle. I want to propose the idea of not converting any, some, or all of your Traditional IRA to a Roth IRA and go against the conventional wisdom. Granted, this strategy has to fit into your overall retirement and financial planning, but I think it’s an option you should consider.
People are living longer today for many reasons, including advanced medical care. It’s estimated that only 5% – 7% of people today have long-term care insurance. The cost of an assisted living facility could be $10,000 to $15,000 a month depending on where you live. Since very few people have long-term care insurance, how do they pay for assisted living? Most people will pay for that with after tax dollars, usually from a savings account. Why, because they don’t want to take it from their Traditional IRA because they have been programmed that this distribution will be taxed. And they are exactly correct!
What they are not told is that the assisted living facility payments also provide a medical tax deduction. With that in mind, don’t pay the assisted living facility costs with after tax dollars, pay with pre-tax dollars.
To make this simple and not complicate it, suppose your annual assisted living expense is $100,000. Now let’s also suppose you have no other income and instead of paying for this out of your savings account, you pay it out of your Traditional IRA. You now have $100,000 of taxable income, but what you also have is a medical tax deduction of $92,500. In addition, let’s suppose you have $10,000 in real estate taxes and no mortgage interest deduction because your house is debt free. Surprise, because of these tax deductions, you have made a taxable transaction, tax free, your taxable income is zero.
I did not mention charitable deductions as an itemized deduction because this should also be made out of your Traditional IRA as a QCD-Qualified Charitable Deduction directly to the charity. This is a deduction in order to calculate your Adjusted Gross Income.
If there are funds left in your Traditional IRA when you pass away, and your spouse is also deceased, you can leave the money to a “non-spouse,” typically your children. They will have to set up an “Inherited IRA” account. The good news is, because of the SECURE Act, they need to withdraw all of the funds within a 10-year period from the date of your death.
While any amount of a ROTH conversion can be an especially useful tool to minimize your tax liability and complement your financial and retirement planning, I hope this article gives you another perspective on ROTH conversions.