31-01-2025
The Retirement Maneuver More People Should Be Making
It's hard to hand over a big portion of your retirement savings when you're old or getting there. Every fiber in your being shrieks 'mistake.' And sometimes it is a mistake, as it was for Bob and Sandy Curtis, who forked out $840,000 in entrance fees for a continuing care retirement community that subsequently filed for bankruptcy.
Other times, though, writing a very big check is exactly the right thing to do for your long-term financial health. I'm referring to 'Rothification,' a maneuver that costs a lot in taxes up front but raises your potential living standard in the long run. I wrote about it last year.
Rothification is the conversion of an ordinary individual retirement account or 401(k) into a Roth I.R.A. For simplicity I'll stick with the case of converting an ordinary I.R.A. to a Roth I.R.A. from here on.
In an ordinary I.R.A., you put in money that hasn't been taxed yet. (You can also put in money that has been taxed, but I'm going to ignore that complication.) Money in the I.R.A. grows tax-deferred. Later, when you withdraw money from the I.R.A. to cover retirement expenses, you pay taxes on the withdrawals as ordinary income. An ordinary I.R.A. can be a good deal if you expect to be in a lower tax bracket in retirement than during your working years — say, because you won't have a lot of retirement savings to draw upon.
A Roth I.R.A., the mirror image, is stuffed with money that's already been taxed. The money grows tax-free, and when you withdraw from it, you don't have to pay any taxes on either the original contribution or any subsequent gains. It's a great deal if your tax bracket in retirement is as high or higher than it was during your working years, as happens more often than many people expect. It can sometimes be a good bet even if you're in a lower tax bracket in retirement: Because the withdrawals don't count toward your taxable income, they help you avoid many years of income-related taxes on Social Security, lower your Medicare premiums and limit required minimum distributions from your ordinary 401(k) or I.R.A., which are taxed.
Now, back to writing that big check. The pain of a Roth conversion comes when the government demands its cut up front. The money you take out of an ordinary I.R.A. to fund the Roth I.R.A. looks like regular income to the Internal Revenue Service and is taxed as such. The maneuver may push you into a higher tax bracket — say from 22 percent to 24 percent, 32 percent, or even 35 percent.
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