The Roth IRA Conversion Trap You Don't Want to Fall Into

If you saved well during your career, you may be approaching retirement with a large sum of money in a traditional IRA or 401(k). That’s a good thing in theory, but it puts you at risk of having large required minimum distributions (RMDs) once you turn 73 or 75, depending on your year of birth.

For many people in that situation, Roth conversions are the solution. Simply move funds out of a traditional retirement account and into a Roth, and you won’t have RMDs to worry about as long as your conversion is complete before those mandatory withdrawals start to come into play.

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But doing a Roth conversion isn’t as easy as it sounds. And there’s one trap you’ll need to take care to avoid.

Don’t let Roth conversions drive your Medicare premiums up

A common window to do Roth conversions is during your 60s. At that stage of life, you may be retired and living on a much lower income than when you worked.

But once you turn 65, you may be inclined to sign up for Medicare. And that means you’ll need to be extra careful with Roth conversions.

Roth conversions count as taxable income each year you make them, and they’re included in your modified adjusted gross income (MAGI). But a higher MAGI could leave you paying more for Medicare.

This year, single tax-filers with a MAGI over $109,000 and joint filers with a MAGI over $218,000 face surcharges on Medicare premiums known as income-related monthly adjustment amounts, or IRMAAs. Those surcharges could potentially add hundreds of dollars a month to the cost of Medicare.

Now, let’s say you have a $1 million traditional IRA you want to convert to a Roth. If you try to do that conversion in five years, you’ll have to move $200,000 a year over. If you’re single, that alone will likely make it so that Medicare costs more.

For this reason, it’s important to stretch your Roth conversion window as much as possible. The more years you give yourself to complete that conversion, the less likely you may be to run into issues with Medicare IRMAAs.

Know how IRMAAs are calculated

If you start Roth conversions in your early 60s, you may have more leeway to move a large sum of money over in a single year (provided you’ve planned for the ensuing tax bill). But you should know that Medicare IRMAAs are calculated based on your MAGI from two years prior.

In other words, if you’re planning to sign up for Medicare at 65, you’ll want to be very careful with Roth conversions at 63. Your income that year could determine if you’ll pay more for Medicare your first year as an enrollee.

All told, the Roth conversion is an excellent strategy for avoiding RMDs and minimizing taxes later in life. But it’s something you need to plan out very carefully, especially if you’re talking about a large sum of money.