Beware of consequences when converting your Roth IRAs
Q. My tax bracket is relatively low because I’m semi-retired at age 63, and some have suggested I convert some retirement funds (403(b) in my case) to Roth IRAs so that the taxes are due while my income is relatively low, and before age 70 1/2 when mandatory distributions will have to begin and my tax bracket is likely to go up. However, I get my health insurance from the Federal exchange, and it looks to me like I will lose the Federal subsidy if I start converting some of those funds now. What should I do?
A. Converting retirement assets to a Roth will cause a tax burden when you make the conversion, and you’re right — there could be ripple effects through the rest of your finances.
Before we continue, make sure you consult with a tax advisor who knows all the particulars of your situation before you make a move.
We called on Eric Furey, a certified financial planner with RegentAtlantic in Morristown, to help with some projections.
Furey said you need to project your 2016 taxes and your taxes in the future when you takeRequired Minimum Distributions (RMDs) start collecting Social Security income and pension income.
He made some assumptions, including that you’re single, your taxable income — part-time income plus portfolio income plus any additional income less your itemized deductions such as mortgage interest, medical expenses and real estate taxes – puts you in the 15 percent tax bracket.
This means your taxable income is between $9,275 and $37,650 for 2016, Furey said.
Fast forward seven years, now you’re taking required distributions and receiving Social Security. The next tax bracket starts at taxable income of $37,650 and goes through $91,150. The tax bracket that follows goes through taxable income of $190,150, Furey said.
“If your tax bracket in retirement will be either 15 or 25 percent, then your savings will be 10 percent of the amount between your taxable income today and $37,650,” he said.
He gave this example: If your 2016 taxable income is $10,000, then you will save $2,765 ($37,650 less $10,000 times the difference in tax brackets). Note you’ll save this every year that you do the conversion so you can save this up to 7 times, which is almost $20,000 in cumulative taxes, Furey said. The savings increases even further if you’re going to be in the 28 percent tax bracket during age 70 and beyond.
If you used the conversation strategy, what are you giving up?
Furey said as you noted, you get government subsidies on healthcare if you are within certain income ranges. For some states, the amount of subsidy is determined by the state and for other states it’s determined federally. In New Jersey, the subsidy is determined by the state, Furey said.
Here’s the next example: If your income is less than $16,394, then you are eligible for Medicaid and do not pay for healthcare. For income between $16,394 and $29,425, you get reduced premiums, and income above $47,080 disqualifies you from any subsidies. Note these potentially increased premiums will only apply for two years as you’ll be changing to Medicare at age 65, Furey said.
Once you become Medicare-eligible, your income has less of an impact on your premium dollars.
“Medicare does conduct income testing, but the thresholds are much higher and the changes are less significant,” Furey said. “The first increase for single filers happens when income exceeds $85,000, the second increase is at income in excess of $107,000, and there are three other increases after that.”
What does it all mean? Set up a meeting with your tax advisor to see exactly how the numbers would work out for you.