If you’ve read my articles or others on Roth conversions, you probably know the most obvious opportunity for Roth conversions exists in the period between retirement and when you start to tap Social Security and retirement accounts.
If you look at a tax projection for someone who is about to retire, rates are often near their peak. They fall off a cliff when wages go away, and then they pop up again once you have required minimum distributions (RMDs) and Social Security income.
If you twist your head a little farther to the right, you’ll see, in our projections, another drop. That drop in your final years of life is due to high medical expenses, which reduce taxable income. While your tax rates are unlikely to go higher, which is the tell-tale sign to consider a Roth conversion, it is likely that your rates at this point are lower than those of your beneficiaries, who will inherit these accounts and pay taxes on the distributions.
Sign up for Kiplinger’s Free E-Newsletters
Profit and prosper with the best of expert advice on investing, taxes, retirement, personal finance and more - straight to your e-mail.
Profit and prosper with the best of expert advice - straight to your e-mail.
Higher medical expenses mean lower taxable income
Taxable income is gross income less deductions. Most people no longer itemize deductions since the Tax Cuts and Jobs Act of 2017 (TCJA), which overhauled our tax code and increased the standard deduction. However, once medical expenses have a significant impact on income, it’s likely that your deductions get above the standard deduction. The higher your deductions, the lower your taxable income. The lower your taxable income, the more appealing Roth conversions can become.
At age 26, I earned my CERTIFIED FINANCIAL PLANNER™ certification. I also hold the IRS Enrolled Agent license, which allows for a unique approach to planning that can be beneficial to retirees and those selling their businesses, who are eager to minimize lifetime taxes and maximize income.
Medical expenses tend to increase as we age. However, entering a retirement community or nursing home can cause those partially deductible expenses to skyrocket. Under the current code, medical expenses in excess of 7.5% of modified adjusted gross income (MAGI) are deductible. When you enter a continuing care retirement community (CCRC) with a lifecare contract or modified contract, some portion of your entry fee and monthly fee are considered to be a pre-paid medical expense. Those are deductible. The finance office at the community should be able to tell you what percentage of the care is considered medical. IRS Publication 502 provides a much more in-depth explanation.
A Roth conversion opportunity
The period when your medical expenses peak late in life has to be one of the least likely times you would analyze your tax return to uncover the silver lining of your less-than-ideal situation. Often, we uncover this opportunity through conversations with clients who are handling their parents’ affairs. We rely on financial planning software to get a rough sense of what future rates will look like for the owner and for the beneficiaries. We rely on tax planning software to run the actual conversion calculation. You can access a free version of the financial planning software we use.
Aging sucks. Paying astronomical amounts for help, medical and otherwise, sucks. Once again, a Roth conversion is probably the last thing on your mind. Try to reframe this as a tax sale. You may be able to pay today at a lower rate than your beneficiaries will in a decade. Maybe that won’t lessen the blow, but those beneficiaries will thank me down the line.
Related Content
-
Planning for Health Care Costs in Retirement: A Comprehensive GuideMedical expenses aren't slowing down, and if you're not prepared, they can hit you like a ton of bricks.
-
When Should You Hand Over the Keys — to Your Investments?The secret to retirement planning? "The best time to hand over the keys is before you’ve realized you need to hand over the keys."
-
When Should You Hand Over the Keys — to Your Investments?
The secret to retirement planning? "The best time to hand over the keys is before you’ve realized you need to hand over the keys."
-
Going to College? How to Navigate the Financial PlanningCollege decisions this year seem even more complex than usual, including determining whether a school is a 'financial fit.' Here's how to find your way.
-
Financial Steps After a Loved One's Alzheimer's DiagnosisIt's important to move fast on legal safeguards, estate planning and more while your loved one still has the capacity to make decisions.
-
How Soon Can You Walk Away After Selling Your Business?You may earn more money from the sale of your business if you stay to help with the transition to new management. The question is, do you need to?
-
Two Don'ts and Four Dos During Trump's Trade WarThe financial rules have changed now that tariffs have disrupted the markets and created economic uncertainty. What can you do? (And what shouldn't you do?)
-
I'm Single, With No Kids: Why Do I Need an Estate Plan?Unless you have a plan in place, guess who might be making all the decisions about your prized possessions, or even your health care: a court.
-
Most Investors Aren't as Diversified as They Think: Are You?You could be facing a surprisingly dangerous amount of concentration risk without realizing it. Fixing that problem starts with knowing exactly what you own.
-
Retire in Malta for Quiet Coastal PerfectionSeemingly remote yet easily accessible to other points in Europe, sunny Malta offers paths to citizenship and residency for families and retirees.
