Before converting a traditional IRA to a Roth, it’s essential to understand a recent rule change under the SECURE Act that impacts your required minimum distributions (RMDs). Previously, you only needed to take the RMD for the IRA you were converting; however, under the new rule, all RMDs across every IRA must be taken before any conversion. Let’s unpack what this means and how you can leverage this knowledge to make the most of your retirement assets.
The New Rule Explained
RMDs are mandatory withdrawals that retirement account holders over age 73 must take each year. Traditionally, you would calculate the RMD based on the account balance at the end of the previous year, divided by the IRS life expectancy factor. These withdrawals are required on all IRAs, except Roth IRAs, and are subject to regular income tax.
For clients interested in converting an IRA to a Roth IRA, there’s a crucial change: before you complete any Roth conversions this year, you must first take out the RMDs owed on all your IRAs—not just on the one you’re converting. This rule adjustment was issued as part of the SECURE Act, making it more important than ever to carefully sequence your RMDs and conversions.
Why the Sequence Matters
Converting a traditional IRA to a Roth is a powerful strategy for tax-free growth, as Roth accounts are funded with after-tax dollars and exempt from future RMDs. However, the timing of your RMDs and conversions is crucial to avoid unexpected tax issues. Here’s how following the new rule benefits you:
- Avoid Excess Contribution Penalties: If you attempt a Roth conversion without first taking out the full RMD amount across all accounts, the IRS will treat the remaining RMDs as an “excess contribution” to your Roth IRA. This will result in penalties and corrective measures, potentially undoing some of your conversion’s intended benefits.
- Stay Tax-Efficient: The correct sequence—taking RMDs first—ensures you’re not increasing the taxable amount by moving required withdrawals into the Roth conversion, which can impact your current year’s taxable income significantly.
- Simplify Compliance: Managing multiple IRAs is complex, and by taking all RMDs up front, you avoid potential tax complications, making it simpler to stay compliant and avoid costly mistakes.
Real-World Scenario
Imagine a client, Jane, with three IRAs who wants to convert one to a Roth. In the past, Jane could have taken the RMD from just that IRA and waited until the end of the year to withdraw from her other accounts. Under the new rule, Jane now must calculate and take her total RMD across all three IRAs before converting any one of them to a Roth.
This change highlights the importance of a carefully sequenced approach to maximize her Roth IRA benefits. If Jane converts without taking all RMDs, the IRS will penalize her, removing the RMD amount directly from her Roth as an “excess contribution.”
Pro Tips for Handling the New RMD Rule
Here are a few tips to help navigate these changes and optimize your Roth conversion strategy:
- Aggregate and Strategize: Add up the total RMDs across all IRAs early in the year. Once you’ve withdrawn the full amount, proceed with your Roth conversion.
- Minimize the Tax Impact: If you anticipate that this new requirement will push you into a higher tax bracket, consider spreading RMDs across multiple accounts to maintain a balanced tax burden.
- Use Our Mega Roth Conversion Guide: For high-net-worth clients planning significant Roth conversions, our Mega Roth Conversion Guide offers a comprehensive approach to making the most of this strategy, even with the new RMD requirements.
In Summary: Knowledge is Power!
This change under the SECURE Act means planning is more critical than ever when considering a Roth conversion. By taking the RMDs from all your IRAs before any conversion, you’ll avoid penalties, optimize tax efficiency, and maximize the growth potential of your Roth accounts. Let’s work together to review your IRA distributions and create a strategy that fits your financial goals, so you’re prepared to enjoy a tax-advantaged retirement.
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Thank you for your continued trust and engagement.
Tony Gomes, Author, MBA
CEO and Founder
Advanced Wealth Management
Content Disclosure: The information here is general and educational. It is not a substitute for professional advice and does not constitute a recommendation. Forecasts and opinions are subject to change.
