By Gail MarksJarvis
CHICAGO (Reuters) - Retirement strategy is about more than just how you will spend the money you have saved – it matters where that money is coming from too.
Bill Reichenstein spent his career teaching finance and creating strategies that help people maximize the amount coming from Social Security. The Baylor University finance professor is a principal in Social Security Solutions, Inc., a software firm that helps people work the system.
But since Reichenstein, 66, retired a few months ago, he has been thinking about how to orchestrate the rest of his retirement accounts and he came up with a plan.
Each year until he is 70, he will convert some of the money that is in his IRA and 401(K) accounts into a Roth IRA. He will pay income tax on whatever he withdraws, but once the money is in the Roth, he never will owe on it again, as the growth is tax-free.
Reichenstein figured out that the conversions will give him more than a couple hundred thousand dollars more than he would have had for retirement because of those tax savings.
At a recent Financial Planning Association Conference, Reichenstein urged financial planners to get retirees in their 60s to adopt the same practice; especially if they have put virtually all their retirement savings into 401(k)s and IRAs.
The driver for this strategy is to protect as much money as possible from taxes that can jump sharply after age 70-1/2. This is when individuals are required by the government to withdraw prescribed sums from IRAs and 401(k)s each year and pay taxes on the distributions, known as required minimum distributions (RMDs). Roth IRAs are not subject to these requirements, and also have easier rules for heirs.
“It makes most sense [to convert] when you quit working and before starting Social Security,” said David Oransky, a certified public accountant and financial planner who serves on the American Institute of CPA's Personal Financial Planning Executive Committee.
For example, Frank Corrado, a Holmdel, New Jersey financial planner and president of the Alliance of Comprehensive Planners, is helping a retired couple do Roth conversions every year for 12 years before hitting 70 and starting Social Security. The couple had adjusted gross income of $141,105 when working, but after retiring at 58 it dropped to about $69,600 as they live on pensions and investments.
With their relatively low income now, they are in the 12 percent tax bracket and can stay within it even though they are converting $32,000 a year to Roths. Over the 12 years before age 70, they will convert about $384,000 of their original $2 million IRA into a Roth. During retirement that should leave them with about $50,000 more to spend, Corrado said.
MORE SAVINGS
The tax saving is about more than just income. Social Security benefits are taxed each year based on a retiree’s other income. So if a person must take a large withdrawal from an IRA, his income will rise and likely lead to more taxes on Social Security benefits.
Medicare premiums are affected too. Most people pay $135.50 a month to have Part B Medicare coverage for doctors and medical tests. But after an individual’s income goes above $85,000 or a couple’s over $170,000, the premium jumps to $189.60 a month per person. As income rises, premiums become as high as $460.50 a month.
During tax season, Oransky suggested thinking about conversions and finishing them the following November when annual income is clear. But people who are planning to move from high tax states to no-income tax states in retirement, may delay a conversion until after the move.
(This story corrects that he will finish conversions at 70, not retire then in paragraph 4 and corrects Oransky's title in paragraph 8)