Ask a group of seniors how they feel about required minimum distributions (RMDs), and you'll probably get a bunch of different answers. Many don't ever have to think about them because they already withdraw more than enough to cover their living expenses each year. For others, they can be a real pain because they don't need the money right now. But they're forced to sell their investments and pay a higher tax bill anyway.
If you fall into the latter camp, the solution isn't to skip your RMD and hope the IRS doesn't notice. That will result in a costly 25% penalty. Instead, you can take your RMD this year and start laying the groundwork to reduce your future RMDs with Roth conversions. But there's a trade-off to doing so.
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How Roth conversions can reduce your future RMDs
Roth accounts and your current 401(k), if you're still working and own less than 5% of the company, are the only accounts exempt from RMD rules once you turn 73. You can still withdraw from these accounts if you want to, but you can do so on your schedule. And you won't pay any taxes on Roth withdrawals because you already paid taxes on those funds when you made the contributions.
A Roth conversion enables you to convert traditional, tax-deferred savings into Roth savings. That can reduce your future RMDs. Your RMDs are based on your account balance as of Dec. 31 of the previous year. If that balance were lower, your RMD would be lower as well.
But there's a catch. When you make a Roth conversion, you must pay taxes on the amount converted. So you're not really avoiding taxes. You're just choosing to pay them at a different time than you would if you'd left the money in a tax-deferred account and paid your RMDs on schedule.
This could still make sense, especially if you expect your income to be lower this year than it will be in the future. Paying the taxes now when you're in a lower tax bracket could save you money compared to waiting a few years and paying a higher marginal rate.
How to do a Roth conversion
If you'd like to do a Roth IRA conversion to reduce your future RMDs, your first step is to decide how much you want to convert this year. Many people wait until the end of the year to do this, when they have a better idea of which tax bracket they'll fall into, and then they convert just enough to reach the top of that bracket. If they want to convert a large amount, they spread this out over several years.
Consult with an accountant if you're not sure how a Roth conversion will affect you. And make sure to complete yours no later than Dec. 31, 2026, if you want it to be applied to your 2027 RMDs.
