I’M NOT IN THE HABIT of celebrating half-birthdays, but my next one has me thinking. In a few days, I'll turn age 59½.
That, of course, is the age at which you can tap your retirement accounts without paying the 10% early withdrawal penalty. Though I don’t currently need to pull spending money from my retirement accounts, I like the feeling that I can now do so penalty-free.
Even without that 10% penalty, however, there’s still the small issue of income taxes. The good news: More than a fifth of my investment portfolio is in tax-free Roth accounts, with another tenth in a regular taxable account. The bad news: The other two-thirds are in a traditional IRA. Every dollar coming out of that traditional IRA will be dunned at ordinary income-tax rates.
That prompted me to do a quick, back-of-the-envelope calculation. If I put off all traditional IRA withdrawals until they’re required at age 72, and I assume modest investment gains, and I add in Social Security benefits and other income, I’ll likely find myself near the top of the 24% federal income-tax bracket when I'm in my 70s. A reliable estimate? Given all the variables involved, I consider it more of a rough guess.
Indeed, based on current tax law, there’s a possibility I could end up paying a 32% marginal rate—and there’s a decent chance tax laws will be different a dozen years from now, especially with parts of 2017’s tax law scheduled to sunset at year-end 2025. On top of that, I’ll most likely have to pay higher premiums for Medicare Part B and Part D, thanks to so-called IRMAA surcharges. For me, those surcharges could amount to an extra tax equal to 2% or 3% of income.
Meanwhile, this year, it looks like I’ll land in the lower part of the 24% marginal federal tax bracket. The upshot: I figure there’s some incentive to shrink my traditional IRA over the next few years, so there’s less risk I’ll end up paying higher taxes—and heftier Medicare premiums—later on. To be sure, by opting to draw down my traditional IRA before I'm compelled to, I’ll be inflicting large tax bills on myself. That's hardly a pleasant prospect.
Still, it strikes me as the rational thing to do. To that end, now that I’m turning age 59½, I could start pulling money penalty-free from my traditional IRA, and continue to do so throughout my 60s. But given that I don’t need the spending money right now, it makes more sense to convert chunks of my traditional IRA to a Roth each year, where the money will then grow tax-free. Keep in mind that you don't have to be age 59½ to do a Roth conversion. Indeed, I've done a few over the years, including a big one in 2010, when I converted my nondeductible IRA.
With the Roth conversions I'm currently planning, my goal is to make the most of the 24% income-tax bracket, but try mightily to avoid generating so much extra income that some of it gets dunned at 32%. The incentive to shrink my traditional IRA is especially great this year and in the three years that follow.
Why? There are two reasons. First, in 2026, I turn age 63, meaning I’ll be two years from claiming Medicare. At that point, any extra income I generate has the potential to boost my Medicare premiums, because the IRMAA surcharges are based on your tax return from two years earlier. Second, in 2026, parts of today’s tax law sunset and, at that juncture, it may take far less income to land in a high tax bracket.
My plan: I’ll convert $60,000 now. Later in the year, when I have a better handle on my 2022 income and how close I am to the top of the 24% tax bracket, I might convert another $10,000 or so. Why not just wait until late 2022 and do a big conversion then? I don’t know whether the stock market will be depressed later in the year—but I know it’s depressed right now. I like the idea that the $60,000 I convert might bounce back with the broad stock market, and that those gains would be tax-free.Jonathan Clements is the founder and editor of HumbleDollar. Follow him on Twitter @ClementsMoney and on Facebook, and check out his earlier articles.