I’m Retiring Next Year. What Should I Do With My 401(k)?

If you are retiring next year, you generally have three choices for your 401(k): leave it in the plan, roll it to an IRA, or use a combination of both. The right decision depends on withdrawal flexibility, taxes, investments, fees, creditor protection, and how the account will help replace your paycheck. At Greenbush Financial Group, we typically recommend building the retirement income plan first and making the rollover decision around that plan.

What Should You Do With Your 401(k) Before You Retire?

One of the biggest mistakes retirees can make is waiting until after their final day of work to figure out what to do with their 401(k).

Before retirement, your 401(k) is primarily an accumulation account. Money goes in, stays invested, and your paycheck covers your living expenses.

After retirement, that account may have a new job: helping replace your paycheck.

That means the decision is about much more than whether an IRA offers more investment choices.

You need to consider:

• Where your monthly income will come from

• How much money should remain liquid

• Which accounts should be withdrawn from first

• How distributions will affect taxes

• Whether you will lose valuable 401(k) provisions by rolling over

• How the account fits with Social Security, pensions, Roth accounts, and taxable investments

In most cases, retirees can leave the money in the 401(k), roll it into an IRA, or potentially use both.

Your 12-Month-Before-Retirement 401(k) Checklist

Ideally, start reviewing your plan several months before your retirement date.

The Department of Labor describes the Summary Plan Description, or SPD, as the document explaining important features of your retirement plan, including when benefits can be received and how the plan operates.

Before you leave your employer:

1. Get your Summary Plan Description. Do not assume every 401(k) works the same way.

2. Confirm withdrawal rules. Can you take partial withdrawals? Monthly distributions? How quickly are requests processed?

3. Identify the different types of money in the account. You may have pretax, Roth, and after-tax balances.

4. Check for employer stock. Appreciated company stock can create special tax-planning considerations.

5. Determine whether the Rule of 55 applies. This can be particularly important if you retire before age 59½.

6. Review any outstanding 401(k) loans. Separation from employment can change how a loan is handled.

7. Review beneficiaries. Make sure your designations still reflect your estate-planning intentions.

8. Estimate your first one to two years of withdrawals. Know how much of your spending must come from investments before deciding where those investments should be held.

That last step is particularly important.

How Will Your 401(k) Replace Your Paycheck?

Suppose you retire and estimate that your household needs $8,000 per month after taxes.

Your Social Security and pension provide $5,000.

That leaves a $3,000 monthly gap.

Where does that $3,000 come from?

Possibilities include:

• Monthly 401(k) distributions

• IRA withdrawals

• Dividends and interest

• A taxable investment account

• A cash reserve

• A combination of several accounts

This is why we prefer to create the withdrawal strategy before deciding whether the 401(k) should be rolled over.

For example, if your employer's plan makes monthly withdrawals cumbersome, an IRA may provide more flexibility. If the 401(k) offers excellent investments and easy recurring distributions, keeping some money there may work perfectly well.

Key Insight: The account should support your retirement income plan. The retirement income plan should not be designed around limitations you discover after completing a rollover.

How Much Should You Keep in Cash When You Retire?

This often becomes a much bigger concern as retirement approaches.

While working, you can generally tolerate market declines more easily because your paycheck continues arriving.

Once you retire, selling investments during a market downturn can be more problematic. You are withdrawing money while the portfolio is temporarily worth less, leaving fewer investments available to participate in a recovery.

This is commonly referred to as sequence-of-returns risk.

There is no single cash amount that is appropriate for every retiree. The appropriate reserve depends on:

• How much of your spending is covered by Social Security or pensions

• Your withdrawal rate

• Other taxable or Roth assets

• Your investment allocation

• Upcoming major expenses

• Your comfort with market volatility

Example

Assume you need $36,000 annually from your portfolio to supplement Social Security.

Rather than relying on stock sales every month, you might keep part of your near-term spending needs in cash or short-term investments while investing money intended for later years differently.

The important point is not that every retiree should use a particular "bucket strategy."

It is that near-term spending needs should influence how the portfolio is structured before retirement begins.

Should You Leave the Money in Your 401(k)?

Keeping money in the employer plan may make sense if it provides:

• Low-cost institutional investments

• Strong investment options

• A stable value fund or other unique option

• Convenient withdrawals

• Strong creditor protection

• Access to special early-withdrawal rules

One of the most important issues for younger retirees is the Rule of 55.

If you separate from service during or after the calendar year in which you turn 55, distributions from that employer's qualified plan may qualify for an exception to the 10% additional tax on early distributions. This particular exception does not apply to an IRA.

Example

You retire at 57 with $900,000 in your current employer's 401(k).

You expect to need $40,000 from retirement accounts before reaching age 59½.

Rolling the entire account into an IRA without first evaluating the Rule of 55 could eliminate a valuable withdrawal option.

That does not mean you must keep the whole 401(k). It means you should understand what you are giving up before moving it.

When Does Rolling the 401(k) to an IRA Make Sense?

An IRA may offer more flexibility for:

• Investment selection

• Recurring withdrawals

• Account consolidation

• Roth conversions

• Portfolio rebalancing

• Tax withholding

• Coordinating multiple sources of retirement income

For a household managing several accounts, simplification can be valuable.

But do not assume an IRA is automatically cheaper.

Compare Fees Apples to Apples

Imagine your 401(k) has:

• 0.10% investment expenses

• 0.15% administrative costs

Your total plan cost may be roughly 0.25%.

Now assume the proposed IRA uses investments costing 0.15% plus a 1.00% advisory fee.

The IRA offers more flexibility, but it is clearly not less expensive.

The opposite can also occur.

When comparing accounts, look at the complete cost:

401(k):

• Plan administrative fees

• Investment expense ratios

• Other participant fees

IRA:

• Advisory fee

• Investment expenses

• Custodial or transaction costs, if applicable

Fees matter, but cost should be evaluated alongside the services, advice, investments, and planning flexibility you are receiving.

Your 401(k) May Contain More Than One Tax Bucket

A large 401(k) does not necessarily contain one type of money.

Your statement may include:

• Pretax 401(k) contributions

• Roth 401(k) contributions

• Employer contributions

• After-tax employee contributions

Those dollars do not necessarily have to go to the same destination.

IRS rules can allow pretax amounts and after-tax amounts from the same distribution to be directed to different eligible accounts. For example, qualifying pretax amounts may go to a traditional IRA while certain after-tax amounts are directed to a Roth IRA.

This is an area where understanding exactly what is inside the plan before requesting a distribution can make a substantial difference.

Roth 401(k) money also has its own tax characteristics, so do not simply tell the recordkeeper to "roll over everything" without knowing how each source will be handled.

Do You Have an Outstanding 401(k) Loan?

Review this before your employment ends.

Depending on the plan and circumstances, separation from service can result in an unpaid plan loan being offset against your account balance. Special rollover rules can apply to a qualified plan loan offset, including a potentially longer period to replace the offset amount than the normal 60-day rollover window.

The specifics matter.

If you have a large outstanding loan, ask the plan administrator exactly what happens when you retire before setting your final retirement date.

How Do RMDs Affect the 401(k) Versus IRA Decision?

Required minimum distributions, or RMDs, eventually force money out of many pretax retirement accounts.

Under current law, RMDs generally begin at age 73 for people currently subject to that starting age, with later starting ages applying to younger generations under SECURE 2.0. Traditional IRAs require RMDs once the applicable age is reached even if you continue working. Employer plans can sometimes permit a still-working employee to delay RMDs until retirement, although plan terms and ownership rules matter.

RMD administration also differs.

If you have several traditional IRAs, the RMDs can generally be calculated for each IRA and the total withdrawn from one or more of those IRAs. RMDs from employer retirement plans generally must be satisfied separately for each plan.

Under current rules, Roth IRAs and designated Roth accounts in plans do not require lifetime RMDs for the original owner.

For someone retiring years before RMDs begin, that gap can also create a valuable window for strategic Roth conversions.

Do Not Forget the Beneficiaries

For many retirees, a $500,000, $1 million, or larger retirement account is also a significant estate asset.

Review:

• Primary beneficiaries

• Contingent beneficiaries

• Whether your spouse should inherit the account

• Whether children or trusts are named

• How inherited-account tax rules may affect beneficiaries

For many non-spouse beneficiaries, current law generally requires an inherited defined-contribution retirement account to be fully distributed within 10 years, although exceptions and additional distribution rules can apply. Surviving spouses have additional options that non-spouse beneficiaries may not have.

That makes beneficiary planning part of the tax plan, not simply an administrative form you completed 15 years ago.

8 Questions to Ask Your 401(k) Provider Before You Retire

Before making a rollover decision, call HR or the plan recordkeeper and ask:

1. Can I leave my money in the plan after retirement?

2. Can I take partial and recurring monthly withdrawals?

3. Are there fees for distributions?

4. What are my total plan and investment expenses?

5. Does my account contain pretax, Roth, or after-tax money?

6. Do I own employer stock, and what is its cost basis?

7. What happens to my outstanding 401(k) loan when I retire?

8. Can I complete a partial rollover and leave the remaining balance in the plan?

Write down the answers. These details can materially change the decision.

Avoid These Common 401(k) Mistakes

The mistakes we see most often are:

• Rolling over automatically because retirement occurred

• Ignoring the Rule of 55

• Moving employer stock without evaluating its tax treatment

• Failing to identify after-tax or Roth money

• Forgetting about a 401(k) loan

• Comparing fees incompletely

• Requesting a check payable directly to yourself

• Moving the account before creating a withdrawal plan

If an eligible rollover distribution is paid directly to you rather than sent through a direct rollover, retirement plans generally must withhold 20% for federal taxes. A properly structured direct rollover generally avoids that withholding.

Final Thoughts

Deciding what to do with your 401(k) is not simply a choice between an employer plan and an IRA.

Your 401(k) is becoming part of your retirement paycheck.

Before moving it, determine:

• How much income your household needs

• Where that income will come from

• How much liquidity you want for the early retirement years

• Whether the plan contains special tax features

• How withdrawals interact with Social Security and taxes

• What you may lose by completing the rollover

At Greenbush Financial Group, we generally recommend building the retirement income and tax plan first, then determining whether the 401(k), an IRA, or a combination of both best supports that strategy.

The goal is not simply to move the money. It is to make sure the money is structured to support the next phase of your financial life.

Rob Mangold

About Rob……...

Hi, I’m Rob Mangold. I’m the Chief Operating Officer at Greenbush Financial Group and a contributor to the Money Smart Board blog. We created the blog to provide strategies that will help our readers personally, professionally, and financially. Our blog is meant to be a resource. If there are questions that you need answered, please feel free to join in on the discussion or contact me directly.

Frequently Asked Questions

1. Should I roll my 401(k) into an IRA when I retire?
   Not automatically. An IRA may provide greater flexibility, while a 401(k) may offer attractive investments, lower costs, creditor protection, or withdrawal provisions worth preserving.
2. Can I leave part of my 401(k) and roll over the rest?
   Some plans allow partial rollovers after retirement. This can allow you to preserve useful 401(k) features while gaining IRA flexibility with the remaining assets.
3. How do retirees take monthly income from a 401(k)?
   Some plans allow recurring monthly distributions. Others have more restrictive withdrawal rules. Check the plan before retirement and compare those provisions with an IRA or other sources of retirement income.
4. How much cash should I have when I retire?
   There is no universal amount. Your appropriate cash reserve depends on your spending needs, guaranteed income, portfolio allocation, other assets, and how much protection you want from having to sell investments during a market decline.
5. Is a 401(k) rollover taxable?
   A properly completed direct rollover of pretax 401(k) money to a traditional IRA generally does not create current taxable income. Moving pretax money to a Roth IRA generally creates taxable income.
6. What happens to my 401(k) loan when I retire?
   It depends on the plan. An unpaid balance may become a plan loan offset after separation, and special rollover rules can apply. Review the loan before selecting your retirement date.
7. Should I review my 401(k) beneficiaries before retiring?
   Yes. Retirement is a good time to confirm primary and contingent beneficiaries and coordinate them with your broader estate and tax plan.

Should I Roll My 401(k) Into an IRA When I Retire?

By Michael Ruger, CFP®
Partner and Chief Investment Officer at Greenbush Financial Group

When you retire, your employer will typically provide information about the options available for your 401(k). 

For most retirees, the primary choices are to leave the money in the former employer's 401(k), roll the balance into an IRA, roll it into another eligible employer plan if available, or take a cash distribution.

Taking the entire account as a taxable cash distribution is usually a very different decision because the taxable portion that isn't rolled over generally becomes taxable income, and additional taxes can potentially apply depending on your age and circumstances.

As a result, many retirees ultimately find themselves deciding between two primary options:

Should I leave my 401(k) with my former employer, or should I roll it into an IRA?

There isn't one answer that works for everyone.

When we're helping clients evaluate this decision, we look at several factors, including:

• Whether the 401(k) allows partial distributions after retirement

• Your age when you leave the employer

• The Rule of 55

• Investment options

• Self-Directing vs Active Investment Management

• 401(k) and IRA fees

• Distribution flexibility

• Roth conversion opportunities

• Qualified charitable distributions

• Required minimum distributions

• Other financial-planning services

• Convenience and account consolidation

• Special investments or employer-plan features that may be lost in a rollover

The decision should be made based on the features of your specific 401(k) plan and what you need from your retirement assets.

First, Find Out Whether Your 401(k) Is a Lump-Sum-Only Plan

One of the first questions to ask before retiring is:

Does my 401(k) allow partial distributions after I leave the company?

This is important because distribution rules can vary by plan.  Some plans provide substantial flexibility after retirement. You may be able to take periodic or partial withdrawals as needed while leaving the remaining balance invested in the 401(k). 

Other plans can be more restrictive.

For example, assume you retire with $300,000 in your 401(k).

You need $20,000 to supplement your retirement income. Ideally, you would simply request a $20,000 distribution and leave the remaining $280,000 invested in the plan.

But if your plan doesn't permit the type of partial distribution you want after separation, taking money from the account may require a different approach, potentially including distributing the account and directly rolling the remaining eligible balance to an IRA.  This is why you should obtain and review your plan's distribution rules before making your retirement decision.

Don't assume every 401(k) works the same way.

The Rule of 55 Can Be a Major Reason to Keep Your 401(k)

For someone retiring before age 59½, one of the most important considerations is the Rule of 55.

Normally, distributions from retirement accounts before age 59½ can be subject to a 10% additional federal tax on early distributions unless an exception applies.

Employer retirement plans have an important exception that generally isn't available for IRAs.

If you separate from service during or after the calendar year in which you reach age 55, distributions from the qualified employer plan associated with that separation may qualify for an exception to the 10% additional tax. Special earlier rules can apply to certain qualified public safety employees.

This can make keeping money in a 401(k) extremely valuable for an early retiree.

An Example of the Rule of 55

Assume you retire from your employer at age 56.

You have $300,000 in that employer's 401(k), and you need $30,000 per year from the account to supplement your retirement income until age 59½.  If you leave the assets in that 401(k) and take qualifying distributions directly from the plan, the taxable distributions are generally subject to ordinary income tax, but the Rule of 55 may allow you to avoid the additional 10% early-distribution tax.

Now suppose you immediately roll the entire $300,000 into a traditional IRA.  The Rule of 55 doesn't apply to IRAs.  If you then take a $30,000 traditional IRA distribution before age 59½, the taxable distribution could potentially be subject to both ordinary income tax and the additional 10% tax unless another IRA exception applies.

For someone retiring between 55 and 59½ who needs access to retirement assets, that distinction can be extremely important.

What If You Retire Before Age 55?

The timing of your separation from employment matters.  Assume you leave your employer at age 53 and fully retire.

You cannot simply wait until age 55 and then begin taking penalty-free distributions from that former employer's 401(k) under the Rule of 55.  The exception generally requires the separation from service to occur during or after the calendar year in which you reach age 55.  If you separated at 53, turning 55 later doesn't retroactively qualify that separation.

There are other exceptions to the 10% additional tax that may apply in certain circumstances, but the Rule of 55 itself would not solve the problem.

The Rule of 55 Doesn't Automatically Apply to All Your Old 401(k)s

Another common misunderstanding involves retirement accounts from previous employers.  Assume you worked for Company A for 15 years and still have $200,000 sitting in its 401(k).

You later work for Company B and accumulate another $300,000 in Company B's 401(k).

You retire from Company B at age 56.

The separation-from-service exception applies to the qualified plan associated with the employer from which you separated after meeting the applicable age requirement. It does not simply turn every old 401(k) you own into a Rule-of-55 account.

That can make consolidation before retirement worth considering.  If your current employer's 401(k) accepts incoming rollovers, you might evaluate moving an older 401(k) into the current employer's plan before separating from service. Then, if you subsequently qualify for the Rule of 55, a larger portion of your employer-plan assets may potentially be available under that exception.

This needs to be completed carefully, and you should confirm both plans' rules before initiating a rollover.

After Age 59½, the Rule of 55 Becomes Less Important

Once you reach age 59½, the early-distribution question changes.

Generally, distributions from both traditional IRAs and qualified employer retirement plans are no longer subject to the 10% additional tax solely because of your age.  That means someone retiring at 63 doesn't need to keep money in a 401(k) simply to preserve the Rule of 55.

At that point, the rollover decision may depend much more heavily on investments, fees, financial-planning services, withdrawal flexibility, charitable strategies, and convenience.

Compare the Investment Options

Investment flexibility is one of the most common reasons retirees consider moving from a 401(k) to an IRA.  A 401(k) generally provides an investment menu selected by the plan.  Perhaps you have 15 funds. Maybe you have 30. Some plans provide excellent low-cost institutional investment options, target-date funds, stable-value investments, brokerage windows, or other choices.

Other plans are much more limited.

If the investments available within the plan provide everything you need, limited choice isn't necessarily a disadvantage. But an IRA can generally provide access to a much broader investment universe. Depending on the custodian and account, you may have access to ETFs, mutual funds, individual stocks, bonds, CDs, and other permissible investments that aren't available in your former employer's 401(k).  For someone who wants a more customized retirement portfolio, that additional flexibility can be valuable.

More Investment Choices Aren't Automatically Better

There is another side to this issue.  Having thousands of investment choices doesn't automatically produce better investment results.  Some retirees prefer a straightforward menu of diversified, low-cost investment funds.

If your 401(k) offers excellent investments at very low costs, moving to an IRA simply because it provides more choices may not accomplish anything.  In some situations, it can actually make investment decisions more complicated.

The important question isn't:

“Which account has more investments?”

It is:

“Which account gives me the appropriate investments for my retirement strategy at a reasonable cost?”

Self-Directed Investing Versus Working With an Advisor

Investment management is another major consideration. 

Many 401(k) participants essentially use a buy-and-hold approach.  They select investments from the plan menu, periodically rebalance, and make changes when they believe changes are appropriate. Some plans also offer managed-account services or other professional investment options.

After retirement, some individuals decide they want more assistance.  They may have a financial advisor who is helping them determine how much they can safely withdraw, how much investment risk they should take, how to coordinate Social Security, and how their investment allocation should change throughout retirement.

Rolling the 401(k) into an IRA may allow that advisor to directly manage the retirement assets as part of the broader financial plan.  However, active management isn't automatically superior to leaving assets in a 401(k), and an advisor's involvement doesn't guarantee better investment performance.  The question is whether the services you receive provide sufficient value relative to their cost.

Compare All of the Fees

Fees should be evaluated before completing a rollover.

Your 401(k) may have:

• Plan administration fees

• Investment management expenses

• Managed-account fees, if applicable

• Other participant-level charges

An IRA can also have costs.

A self-directed IRA at a low-cost custodian may have relatively low account expenses, but the investments themselves still have expenses.  

If you hire an investment advisor, you may also pay an advisory fee.

The IRA option could therefore be cheaper or more expensive than your existing 401(k).

Your 401(k) May Have Access to Lower-Cost Share Classes

One potential advantage of a large employer retirement plan is purchasing power.  A 401(k) may have access to institutional or other lower-cost mutual-fund share classes that aren't available to you as an individual investor in an IRA.

For example, a particular mutual fund might have a lower expense ratio inside a large employer plan than the retail version available outside the plan. That can make the 401(k) surprisingly cost-effective.  This consideration is particularly relevant to mutual funds because different share classes can carry different expenses.

ETFs and individual stocks don't generally use the same mutual-fund share-class structure, so the comparison works differently. Before rolling over, compare the actual investments and actual costs rather than assuming an IRA will be cheaper.

What Additional Services Do You Receive With an IRA?

Investment cost is only one side of the value equation.  Suppose leaving your 401(k) where it is costs less than moving the assets to an IRA managed by an advisor.  That doesn't automatically mean keeping the 401(k) is the better decision.

What services are included in the advisory relationship?

Perhaps the advisor is also providing:

• Retirement income planning

• Social Security analysis

• Roth conversion planning

• Tax planning

• Investment management

• Cash-flow planning

• Medicare and IRMAA planning

• Estate-planning coordination

• Beneficiary reviews

Those services have value.  If you are paying a higher fee, you should understand what you're receiving for that additional cost and decide whether those services are important to you.  On the other hand, if you're comfortable managing your own investments and financial plan, paying an additional advisory fee may not provide sufficient value.

Is a 401(k)-to-IRA Rollover Taxable?

This is one of the most common questions we receive.  Generally, a properly completed direct rollover of pre-tax assets from a 401(k) to a traditional IRA does not create current income tax.

The money remains within the retirement-account system.  If you have designated Roth 401(k) assets, those assets would generally be directed to an appropriate Roth account, such as a Roth IRA, rather than being combined with your pre-tax traditional IRA.

The important distinction is between a rollover and a cash distribution.

If you have the 401(k) send eligible assets directly to the receiving IRA custodian, the transaction can generally be completed without current taxation.  If the check is instead made payable to you, different withholding and 60-day rollover rules can apply.  For that reason, direct rollovers are generally the cleaner method when the objective is simply moving retirement assets from one custodian to another.

Be Careful With the 20% Mandatory Withholding Rule

There is a common misconception that every withdrawal from a 401(k) automatically requires 20% federal tax withholding. 

The actual rule is more specific.

Generally, a taxable eligible rollover distribution paid directly to you from a 401(k) is subject to mandatory 20% federal income-tax withholding. For example, suppose you request a $50,000 eligible rollover distribution and have the money paid directly to you.  The plan may be required to withhold $10,000 for federal income taxes, leaving you with $40,000.

However, the 20% rule doesn't apply to every possible 401(k) payment. RMDs, for example, aren't eligible rollover distributions, and certain periodic distributions also have different withholding rules.

The disadvantages if you are in a lower than a 20% federal tax bracket the 401K plan is over withholding and you have to wait until you file your taxes to get that money back so essentially you've given the IRS and it's your free loan for the year.

With IRAs, you have full control over your tax withholding amount or elect no withholding.  

An IRA May Provide Greater Roth Conversion Flexibility

Roth conversions are another important consideration. Once someone retires, their taxable income may decline substantially.  That can create opportunities to intentionally convert traditional retirement assets to Roth assets during lower-income years.

Some employer plans allow in-plan Roth conversions or rollovers.  Others don't.

If your former employer's plan doesn't provide the Roth conversion flexibility you need, moving eligible pre-tax assets into a traditional IRA can make the process more straightforward.  You can then evaluate conversions from the traditional IRA to a Roth IRA each year based on your tax bracket, future RMDs, Medicare IRMAA thresholds, state taxes, and other planning considerations.

This doesn't mean you should roll a 401(k) into an IRA solely because Roth conversions exist. It means Roth conversion flexibility should be one item on the comparison list.

Qualified Charitable Distributions Can Favor an IRA

Charitably inclined retirees have another reason to consider IRA assets.

Once an IRA owner reaches age 70½, they may become eligible to make Qualified Charitable Distributions, commonly called QCDs.  A QCD generally involves directing money from an eligible IRA directly to an eligible charitable organization.  If all of the requirements are satisfied, the qualifying distribution can be excluded from taxable income.

QCDs can also count toward satisfying an IRA owner's RMD once RMDs apply.

However, QCDs generally must come from an IRA. A distribution made directly from a 401(k) to charity doesn't qualify as a QCD under the IRA QCD rules.

A QCD and RMD Example

Assume you are age 75 and have a $50,000 RMD.

You also plan to give $20,000 to charity.

If the RMD is coming from a 401(k), you generally need to satisfy that plan's RMD according to the applicable employer-plan rules. You can't simply call $20,000 sent from the 401(k) to charity a QCD.

Now assume instead that the assets are in a traditional IRA.

You could potentially direct $20,000 from the IRA to eligible charities as QCDs. Assuming all requirements are satisfied, the $20,000 can count toward the IRA's RMD while being excluded from taxable income. You could then distribute the remaining $30,000 to yourself to complete the $50,000 RMD. Instead of potentially recognizing the full $50,000 as taxable IRA income, only the remaining taxable portion distributed to you would generally be included, assuming the QCD was otherwise fully excludable.

For someone who already gives significant amounts to charity, this can be a valuable planning tool.

You Can't Satisfy a 401(k) RMD With an IRA Distribution

Required minimum distribution rules also become important when deciding whether to consolidate accounts.  If you own multiple traditional IRAs, you generally calculate the RMD for each IRA but can aggregate the total and take the required amount from one or more of those IRAs.

401(k)s work differently.

RMDs from 401(k) plans generally must be calculated and satisfied separately for each applicable plan.  That means if your former employer's 401(k) has a $30,000 RMD, you generally cannot take an extra $30,000 from your traditional IRA and use that distribution to satisfy the 401(k)'s RMD.  This can create additional administrative work for retirees with several old employer plans.

Consolidating Accounts Can Make Retirement Easier

By the time someone retires, it isn't unusual to have accounts spread across several institutions.  Perhaps you have an old 401(k) at one provider, your current 401(k) at another, an IRA at a third custodian, and a brokerage account somewhere else.

While you were working and accumulating money, that might not have been a major problem. In retirement, it can become more cumbersome.  Now you are taking distributions. You may be processing Roth conversions. You need to track RMDs. You need to maintain beneficiary designations. You may be rebalancing investments across accounts.

Having retirement assets consolidated with fewer custodians can make those tasks easier.  It can mean fewer statements, fewer websites, fewer passwords, and fewer places where beneficiary information needs to be maintained.  Convenience by itself shouldn't dictate a rollover decision, but it has value.

Former Employer Plans Can Change Providers

Another practical consideration is that you no longer control what happens with your former employer's retirement plan.  The employer might use one recordkeeper today and switch to another several years from now.

The investment menu may change.

Funds can be replaced.

Websites and distribution procedures can change.

You may receive a notice saying the plan is transitioning to another provider and need to establish new access to the account. None of those changes necessarily make the 401(k) a bad option. But some retirees prefer knowing that their IRA is established with a custodian they selected rather than remaining tied to decisions made by a former employer.

Don't Forget About the Advantages You May Lose by Leaving the 401(k)

So far, many of the rollover considerations have favored IRAs.

But 401(k)s can have important advantages that should not be overlooked.

The Rule of 55 is one.

Low-cost institutional investments can be another.

Some plans offer attractive stable-value or guaranteed investment options that may not be available in an IRA.

Employer plans can also have creditor-protection characteristics that differ from IRAs. Federal ERISA protections can be particularly strong for qualifying employer plans, while IRA creditor protection can depend on bankruptcy rules and state law.

Another important issue involves employer stock.

If your 401(k) contains highly appreciated employer securities, there may be a special tax strategy known as net unrealized appreciation, or NUA. Rolling employer stock into an IRA without evaluating the NUA rules first could eliminate a potentially valuable tax-planning opportunity.  This is one of the situations where you should be particularly careful about automatically rolling an entire 401(k) into an IRA.

A Rollover Doesn't Have to Be All or Nothing

Depending on the plan's rules, you may not necessarily have to choose between keeping 100% of the money in the 401(k) and rolling 100% into an IRA.  Sometimes a partial rollover can accomplish multiple objectives.

For example, an early retiree might keep enough money in the 401(k) to fund anticipated distributions between ages 56 and 59½ under the Rule of 55 while rolling another portion to an IRA for broader investment management. 

Or someone might retain a particularly attractive investment within the 401(k) while moving other eligible assets to an IRA. Whether this is available depends on the plan.

Again, the first step is understanding the actual rules of your 401(k).

Questions to Ask Before Rolling Over Your 401(k)

Before making the decision, we would generally want answers to questions such as:

1. Does the 401(k) allow partial distributions after retirement?

2. Am I retiring before age 59½, and could I benefit from the Rule of 55?

3. What are the total costs of keeping the money in the 401(k)?

4. What would the total costs be in an IRA?

5. Does the 401(k) offer investments I would lose by rolling over?

6. Would an IRA provide investment options or management that I actually need?

7. Does the 401(k) contain employer stock that should be evaluated for NUA treatment?

8. Do I plan to make QCDs in retirement?

9. Do I expect to process Roth conversions?

10. Would consolidating my retirement accounts make distributions and RMD planning easier?

11. Am I receiving additional financial-planning services in exchange for any higher advisory fee?

Those answers provide a much stronger basis for making the rollover decision than simply saying, “Everyone rolls their 401(k) into an IRA when they retire.”

So, Should You Roll Your 401(k) Into an IRA When You Retire?

For many retirees, rolling a 401(k) into an IRA can provide significant advantages.

An IRA may offer a broader investment selection, easier account consolidation, greater distribution flexibility, access to QCDs, straightforward Roth conversion planning, and the ability to have an advisor directly manage the assets as part of a broader retirement plan.  But that doesn't mean everyone should roll over their 401(k).

Someone retiring between age 55 and 59½ may have an important reason to preserve access to the Rule of 55.  Another retiree may have exceptionally low-cost investments inside the 401(k).

Someone else may have a stable-value investment they cannot replicate in an IRA.  And a participant with appreciated employer stock may need to evaluate NUA treatment before making any rollover decision. The best approach is to compare the accounts side by side.

Look at taxes, investments, fees, withdrawal flexibility, early-retirement rules, Roth conversions, charitable planning, RMDs, creditor protection, investment management, and convenience.

A 401(k)-to-IRA rollover is generally an irreversible planning decision in the sense that you may not be able to recreate every feature you gave up once the assets leave the former employer's plan. For that reason, the rollover decision should be made because the IRA is a better fit for your retirement strategy—not simply because you retired.

About Michael……...

Hi, I’m Michael Ruger. I’m the managing partner of Greenbush Financial Group and the creator of the nationally recognized Money Smart Board blog . I created the blog because there are a lot of events in life that require important financial decisions. The goal is to help our readers avoid big financial missteps, discover financial solutions that they were not aware of, and to optimize their financial future.

Frequently Asked Questions About Rolling a 401(k) Into an IRA After Retirement

1. Should I roll my 401(k) into an IRA when I retire?
   It depends on the features of your 401(k) and what you need during retirement. An IRA may provide more investment choices, withdrawal flexibility, Roth conversion options, QCD planning, and easier consolidation. However, a 401(k) may offer lower-cost investments, special creditor protections, the Rule of 55, or investments that aren't available in an IRA. Compare the specific options before moving the account.
2. Is there a tax penalty for rolling a 401(k) into an IRA?
   Generally, a properly completed direct rollover of pre-tax 401(k) assets into a traditional IRA does not create current income tax or the 10% additional tax. A direct rollover moves the money directly from the employer plan to the receiving retirement account. Different tax consequences can arise if money is paid to you and isn't properly rolled over or if pre-tax money is intentionally converted to Roth.
3. What is the Rule of 55 for a 401(k)?
   The Rule of 55 is an exception to the 10% additional federal tax on certain early retirement-plan distributions. Generally, if you separate from service during or after the calendar year in which you reach age 55, distributions from the qualifying employer plan associated with that separation may avoid the additional 10% tax. The exception does not generally apply to IRAs.
4. Should I roll over my 401(k) if I retire at age 55 or 56?
   Be particularly careful before doing so. If you separated from the employer during or after the year you reached age 55 and need retirement-account distributions before age 59 1/2, keeping enough assets in the qualifying 401(k) may allow you to use the Rule of 55. Rolling those assets to an IRA could cause subsequent IRA withdrawals before 59 1/2 to lose that particular exception.
5. Is an IRA cheaper than a 401(k)?
   Not necessarily. Some 401(k) plans provide access to very low-cost institutional investments, while others have higher administrative or investment costs. IRAs can also range from inexpensive self-directed accounts to advisor-managed accounts with additional fees. Compare the total costs and services of both options rather than assuming one is always cheaper.
6. Does a 401(k) have more or fewer investment options than an IRA?
   A typical 401(k) offers a predetermined investment menu, while an IRA can generally offer a much broader selection of permissible investments. However, some 401(k)s offer excellent institutional funds, stable-value options, or brokerage windows. More choices do not automatically mean a better investment portfolio.
7. Can I do a Roth conversion directly from my 401(k)?
   Some 401(k) plans allow in-plan Roth conversions or other Roth rollover options, but plan features vary. If the plan doesn't provide the desired Roth conversion functionality, eligible pre-tax assets can potentially be rolled into a traditional IRA and subsequently converted to a Roth IRA. The conversion creates taxable income, so the tax impact should be evaluated first.
8. Can I make a qualified charitable distribution from a 401(k)?
   QCDs generally must be made directly from an eligible IRA rather than directly from a 401(k). An eligible IRA owner who has reached age 70 1/2 can potentially direct qualifying IRA assets to eligible charities, and those QCDs can count toward an IRA RMD once RMDs apply. Charitably inclined retirees may therefore want to consider QCD availability when comparing a 401(k) with an IRA.
9. Can I use an IRA withdrawal to satisfy my 401(k) RMD?
   Generally, no. Traditional IRA RMDs can generally be aggregated with other traditional IRA RMDs and withdrawn from one or more IRAs. However, RMDs from 401(k) plans generally must be calculated and satisfied separately from each applicable employer plan. You normally cannot take an additional IRA distribution to satisfy a separate 401(k) RMD.
10. What should I check before rolling over my 401(k) after retirement?
    Review the plan's distribution rules, the Rule of 55 if you are under 59 1/2, investment choices, fees, employer stock and possible NUA treatment, creditor protection, Roth conversion options, QCD planning, RMD administration, advisory services, and the convenience of consolidating accounts. Once you understand what you would gain and what you would give up, you can make a much more informed 401(k)-versus-IRA decision.

Should You Process Roth Conversions Before You Retire?

By Michael Ruger, CFP®
Partner and Chief Investment Officer at Greenbush Financial Group

As you approach retirement, one of the biggest tax-planning questions you may encounter is whether you should begin converting some of your pre-tax retirement accounts to a Roth IRA.

Roth conversions can be a powerful retirement tax strategy when used correctly. They can allow you to take advantage of temporarily lower tax brackets, reduce the amount of money accumulating in pre-tax retirement accounts, potentially reduce future required minimum distributions, and create a larger pool of tax-free assets for later in retirement. 

But a Roth conversion isn't automatically a good strategy simply because you are approaching retirement.  In fact, processing a large Roth conversion during the wrong year can result in paying substantially more in taxes than necessary.

When we evaluate Roth conversions as part of a financial plan, some of the most important considerations include:

• Your current federal and state income tax brackets

• Your expected tax brackets after retirement

• Whether you are experiencing an unusually low-income year

• The amount you have accumulated in pre-tax retirement accounts

• Your expected future required minimum distributions

• Where you live now and where you plan to live in retirement

• Potential future inheritances

• Medicare premiums once you reach Medicare age

• How you plan to pay the taxes generated by the conversion

The real question isn't simply, “Should I do a Roth conversion?”  A better question is, “At what tax rate does it make sense for me to convert pre-tax retirement assets to Roth assets?”

What Is a Roth Conversion?

A Roth conversion involves moving money from a pre-tax retirement account, such as a traditional IRA, into a Roth IRA.  Some 401K plan even allow “in plan Roth conversions” from pre-tax to a Roth source within the plan.

The important part is what happens for tax purposes.

Generally, the taxable portion of the amount converted from a traditional IRA to a Roth IRA is included in your taxable income for that year. You are essentially choosing to pay the income tax today in exchange for moving those assets into the Roth environment.

Why would you voluntarily accelerate a tax bill?  Because qualified Roth IRA distributions can eventually be tax-free, and Roth IRAs are not subject to lifetime required minimum distributions for the original owner. By paying tax today, you may be able to create greater tax flexibility later in retirement.  The strategy can be particularly attractive if you can pay tax on the conversion at  the same or lower tax rate today, compared to the one you would pay in the future during the retirement years.

Be Careful With Roth Conversions During Your Peak Earning Years

One of the biggest mistakes we see in Roth conversion planning is focusing only on the benefits of the Roth IRA without considering the tax cost of getting the money there.  Imagine that you are 60 years old, still working, and earning one of the highest salaries of your career.  You decide to convert $200,000 from your traditional IRA into a Roth IRA.

That $200,000 doesn't replace your salary for tax purposes. Generally, the taxable conversion amount is added on top of your other taxable income.  If you are already in a high federal income tax bracket—and potentially paying state income tax as well—the conversion could result in a very large tax bill.  This is why Roth conversions immediately before retirement aren't always advantageous.

If you're going to retire in two years and your taxable income is expected to fall dramatically, why voluntarily recognize a large amount of additional income while you are still in one of your highest tax brackets?  In some situations, waiting until retirement may provide a much better opportunity.

The Ideal Roth Conversion Opportunity: An Abnormally Low-Income Year

Some of the best Roth conversion opportunities occur when someone's income temporarily drops.  This can happen before or after retirement.  Consider a self-employed consultant who normally generates approximately $700,000 of annual income.  For whatever reason, the business has a difficult year and the consultant only generates $100,000.  If the consultant expects income to return to $700,000 the following year, that temporary decline may create an opportunity.

Instead of allowing lower tax brackets to go unused, the business owner could evaluate converting some traditional IRA assets to a Roth IRA and intentionally recognizing additional taxable income during the lower-income year.

The key word here is intentionally.

Rather than picking an arbitrary conversion amount, the taxpayer and their advisors can estimate taxable income for the year and determine how much could potentially be converted at acceptable marginal tax rates.  This concept is often referred to as filling up the tax brackets.

Roth Conversions When One Spouse Retires Before the Other

Another common opportunity occurs when spouses retire at different times.  Suppose both spouses have historically earned $150,000 per year. Their combined employment income is approximately $300,000.

Now assume one spouse retires at age 60 while the other continues working.

Their employment income suddenly falls from $300,000 to approximately $150,000.

Depending on their deductions and other income, this reduction could create room in lower tax brackets that wasn't available while both spouses were working.  Instead of waiting until both spouses are retired, the couple could evaluate whether the period between the first and second retirement provides an attractive Roth conversion window.  This is why Roth conversion planning often works best when it is mapped out over multiple years, rather than making the decision one year at a time.

What If Your Retirement Tax Rate Won't Be Lower?

A common assumption is that everyone moves into a lower tax bracket after retirement.  That isn't always true.  Some retirees accumulate very large balances in traditional IRAs, 401(k)s, 403(b)s, and other pre-tax retirement accounts.  Eventually, distributions from those accounts can create substantial taxable income.

Required minimum distributions can also force money out of certain retirement accounts later in life, whether you need the income or not. Under current federal rules, traditional IRA owners generally begin RMDs at age 73, although applicable starting ages depend on birth year under current law.

For someone with significant pre-tax retirement assets, future taxable income may not decline nearly as much as expected.  That can strengthen the case for evaluating Roth conversions earlier.

The $1 Million Traditional IRA Example

Assume you have $1 million in a traditional IRA.

You don't expect to need most of that money during the next decade.  Over time, assume hypothetically that the account grows from $1 million to $2 million.

If the money remains in the traditional IRA, you have another $1 million of investment growth inside an account whose future taxable distributions will generally be subject to ordinary income tax.  Now consider converting some of the traditional IRA to a Roth IRA today.  You pay tax on the taxable conversion amount now, but future growth on the converted assets occurs inside the Roth IRA. If the applicable requirements are satisfied, qualified Roth distributions can eventually be received tax-free.

This can make Roth conversions particularly attractive when you expect your future marginal tax rate to be similar to or higher than your current rate.  But there is an important caveat.

Don't Ignore the Tax Dollars You Give Up Today

It is easy to compare $1 million in a traditional IRA with $1 million in a Roth IRA and conclude that the Roth is obviously better.  But those aren't economically equivalent balances.  The traditional IRA contains money on which taxes generally haven't been paid yet. Converting it to Roth requires paying that tax. 

Suppose a conversion would result in a combined federal and state marginal tax cost of 40%.  That is a substantial upfront tax expense.  If you pay the conversion tax from other assets, those dollars are no longer available to remain invested elsewhere. If you pay the tax from the IRA itself, less money makes it into the Roth account.  That tax cost has to be included in the analysis.

In some situations, particularly when the current marginal tax rate is very high and the expected future tax rate is lower, not converting can produce a better financial result.  This is why Roth conversion planning should involve an actual tax analysis rather than simply assuming that Roth accounts are always better than traditional retirement accounts.

New York Residents Have an Additional Roth Conversion Consideration

State income taxes can have a significant impact on Roth conversion decisions.  New York provides a useful example.

Under current New York rules, taxpayers who meet the age requirements may exclude up to $20,000 of qualifying pension and annuity income from New York adjusted gross income. Married taxpayers who both have qualifying income can each potentially qualify for their own exclusion. New York's published guidance also recognizes qualifying IRA distributions, and state guidance specifically addresses Roth conversion income within the pension and annuity exclusion rules.

For a married couple in which both spouses qualify, this can potentially create an opportunity to convert qualifying amounts from traditional IRAs while reducing or eliminating New York income tax on a portion of the conversion. 

Consider a hypothetical married couple who are both over age 59½ and each has a traditional IRA.  If each spouse qualifies to use the full $20,000 exclusion against conversion income, they could potentially convert a combined $40,000 per year while excluding that qualifying amount for New York income-tax purposes.

If they did that for five years, they could potentially move $200,000 from traditional IRAs to Roth IRAs while using the available New York exclusions each year, assuming they continue to meet all applicable requirements.  Federal income tax can still apply to those conversions.

Also, the $20,000 New York exclusion is not an additional $20,000 exclusively reserved for Roth conversions. Other qualifying pension or annuity income can use some or all of the same annual exclusion.  This is why the taxpayer's entire income picture needs to be reviewed each year.

Your Future State of Residence Can Completely Change the Analysis

Now let's look at the state-tax question from the opposite direction.  Assume you currently live and work in a state that imposes an income tax.  However, you know that immediately after retirement you plan to establish residency in a state with no individual state income tax.  Processing a large Roth conversion immediately before moving could potentially mean voluntarily paying state income tax that might have been avoided by waiting.

For example, imagine converting $500,000 while still domiciled in a state that taxes the conversion.  If you instead retire, legitimately establish residency in a state without an individual income tax, and then process the conversion, the state-tax result could be materially different.  Of course, residency and domicile involve specific rules, and moving to another state should not be treated as simply changing your mailing address.

But the larger planning point is important:

Where you live when the Roth conversion occurs can matter.

When someone is already planning a move in retirement, we want to coordinate the timing of Roth conversions with that move rather than viewing those decisions separately.

A Future Inheritance Can Affect Today's Roth Conversion Strategy

Potential inheritances can also influence Roth conversion planning.  Suppose you are 60 years old and your parents are in their mid-80s.  Your parents have accumulated substantial balances in traditional retirement accounts, and based on their current financial position, you expect that you may eventually inherit some of those assets.

Under current federal rules, many non-spouse designated beneficiaries who are not eligible designated beneficiaries generally must empty an inherited retirement account by the end of the tenth year following the original owner's death. Depending on when the owner died relative to their required beginning date and the beneficiary's status, annual distribution requirements can also apply during that period.

Taxable distributions from an inherited traditional IRA generally become income to the beneficiary.  Now imagine inheriting a $1 million or $2 million traditional IRA while you already have significant pre-tax retirement assets of your own.  That inheritance could materially increase taxable income during your retirement years.

In that situation, the assumption that “I'll be in a lower tax bracket after I retire” may turn out to be incorrect.  If a significant inheritance is reasonably anticipated, it may be worth modeling whether converting some of your own traditional IRA assets earlier could reduce future tax concentration.

However, inheritances are inherently uncertain. Timing, asset values, healthcare expenses, estate-plan changes, and other circumstances can all change. For that reason, we generally would not want an entire Roth conversion strategy to depend on receiving a particular inheritance at a particular time.

Roth Conversions Can Affect Medicare Premiums

Medicare adds another important consideration.

Higher income can result in income-related monthly adjustment amounts, commonly called IRMAA, being added to Medicare Part B and Part D premiums.  Roth conversions increase taxable income in the year of conversion and can therefore potentially result in higher Medicare premiums later, because Medicare generally uses income information from two years earlier when determining IRMAA. 

This is particularly important for someone processing large Roth conversions at or after Medicare age.

However, there can also be a longer-term planning benefit.  Reducing traditional IRA balances through Roth conversions may reduce future required minimum distributions. Lower future taxable income could potentially help reduce exposure to higher Medicare premiums in later years.  In other words, Roth conversions don't automatically lower Medicare premiums.

A conversion could increase Medicare premiums in the short term while potentially helping control taxable income and Medicare costs later.  That tradeoff needs to be included in the analysis.

Be Careful With Tax Withholding on Roth Conversions

Another important consideration is how you pay the tax generated by a Roth conversion.  Suppose a 53-year-old wants to convert $100,000 from a traditional IRA to a Roth IRA.  Assume the conversion creates an estimated $30,000 federal and state tax liability.  Ideally, if appropriate and sufficient funds are available, the individual may consider paying that tax from cash or another non-retirement source so the entire $100,000 can reach the Roth IRA.

Why?

If $30,000 is withheld from the traditional IRA and only $70,000 actually reaches the Roth IRA, the withheld $30,000 is not part of the conversion. For someone under age 59½, amounts distributed and not rolled over may also be subject to the 10% additional tax on early distributions unless an exception applies. The IRS specifically illustrates this principle for rollover withholding.

That can make using retirement assets to pay conversion taxes particularly costly for someone younger than 59½.  Once someone is over age 59½, the 10% early-distribution tax generally no longer applies based solely on age. However, withholding taxes from the retirement account still means fewer dollars ultimately reach the Roth IRA.  For that reason, even after age 59½, paying the conversion tax from outside assets may be preferable when the overall financial plan supports it.

Why We Often Wait Until Later in the Year to Process Roth Conversions

Timing during the calendar year is another important part of Roth conversion planning.  When possible, we often prefer to make final Roth conversion decisions later in the year.

Why?

Because income has a way of surprising people.  This is especially true for business owners, executives, sales professionals, and anyone whose compensation includes bonuses, commissions, stock compensation, or other variable income.  Consider an employee earning a $200,000 base salary who plans to process a $50,000 Roth conversion.

In March, everything looks straightforward.

The employee processes the $50,000 conversion.

Then the company has an exceptional year and, in November, the employee receives an unexpected $100,000 bonus.

That bonus may push some or all of the Roth conversion income into a higher marginal tax bracket than originally anticipated.  Had the employee known about the bonus before converting, they might have reduced the conversion or skipped it entirely for that year.

November and Early December Can Be Good Planning Windows

By November or early December, you may have a much clearer picture of your annual income.

W-2 employees generally have a good idea of their salary, bonuses, and other compensation.  Business owners have most of the year's financial results available.  Investment income, capital gains, pension payments, and other income sources are also easier to estimate.  At that point, you and your tax and financial professionals can prepare an income projection and determine how much Roth conversion room may be available within your desired tax brackets.

However, there is another side to this strategy:

Don't wait until December 31.

Financial institutions can have year-end processing deadlines, and conversion requests may require time to complete. Waiting until the final days of December creates the risk that the transaction will not be completed during the intended tax year.  If you are considering a year-end Roth conversion, contact your custodian well in advance and determine its processing deadlines.

Roth Conversion Planning Should Be a Multi-Year Strategy

Perhaps the biggest mistake is viewing a Roth conversion as a one-time, all-or-nothing decision.  Imagine that you have $800,000 in a traditional IRA.

The question isn't necessarily:

“Should I convert the entire $800,000?”

Doing so in one year could create an enormous tax bill and push a significant amount of the conversion into higher tax brackets.  Instead, perhaps the better strategy is converting $50,000 this year, $80,000 next year, $100,000 during the first year of retirement, and additional amounts during subsequent lower-income years.  The appropriate numbers will be different for everyone.

This approach allows you to potentially fill lower tax brackets over multiple years rather than creating one enormous taxable event.

The years immediately following retirement can sometimes provide an especially valuable Roth conversion window. Employment income may have stopped, Social Security may not have started, and required minimum distributions may still be years away.

That gap can provide opportunities to recognize income intentionally at tax rates you find acceptable.

So, Should You Process Roth Conversions Before Retiring?

Sometimes.

Roth conversions before retirement can make a lot of sense when you encounter an unusually low-income year, when one spouse retires before the other, when current and expected future tax rates are similar, when you have substantial pre-tax retirement balances, or when future income—including potential inherited retirement assets—could push you into higher tax brackets.

They can also make sense when state-specific tax provisions create an opportunity.  But there are equally valid reasons to wait.  If you are currently in your peak earning years and expect your income to fall substantially after retirement, converting today could mean voluntarily paying tax at a much higher rate.

If you plan to move from a state with an income tax to a state without one, waiting could potentially produce state-tax savings.  And if you are approaching Medicare or already enrolled, the impact of conversion income on IRMAA should also be considered.

The goal isn't simply to get as much money into a Roth IRA as possible.

The goal is to determine when and how much to convert so that you can potentially reduce the amount of tax you pay over your lifetime while maintaining flexibility throughout retirement.

That requires looking beyond this year's tax return.  A good Roth conversion analysis considers your current tax brackets, projected retirement income, Social Security, pensions, required minimum distributions, Medicare premiums, state taxes, investment growth, estate planning, and potentially even inherited retirement assets.  When all of those variables are considered together, Roth conversions can become a powerful component of a comprehensive retirement tax strategy.

About Michael……...

Hi, I’m Michael Ruger. I’m the managing partner of Greenbush Financial Group and the creator of the nationally recognized Money Smart Board blog . I created the blog because there are a lot of events in life that require important financial decisions. The goal is to help our readers avoid big financial missteps, discover financial solutions that they were not aware of, and to optimize their financial future.

Frequently Asked Questions About Roth Conversions Before Retirement

1. Should I do a Roth conversion before I retire?
   A Roth conversion before retirement may make sense if your current marginal tax rate is lower than or similar to the rate you expect to pay later. It can be particularly attractive during an unusually low-income year or when one spouse retires before the other. However, individuals in their peak earning years may benefit from waiting until retirement if their taxable income is expected to decline substantially.
2. What is the best age to do a Roth conversion?
   There is no single best age for a Roth conversion. The best opportunities are often determined by your tax bracket rather than your age. Low-income years between retirement and the beginning of Social Security or required minimum distributions can be particularly valuable conversion windows. Your state taxes and Medicare situation should also be considered.
3. How much should I convert from my traditional IRA to a Roth IRA?
   The appropriate Roth conversion amount depends on your taxable income, deductions, federal and state tax brackets, Medicare considerations, and expected future income. Rather than choosing an arbitrary amount, many taxpayers evaluate how much they can convert while remaining within a targeted marginal tax bracket. A multi-year conversion strategy can sometimes be more tax-efficient than converting a large balance all at once.
4. Do I pay taxes when I convert a traditional IRA to a Roth IRA?
   Generally, yes. The taxable portion of a traditional IRA converted to a Roth IRA is included in income for the year of conversion. If the traditional IRA contains nondeductible contributions, the tax calculation can be more complicated. The conversion itself should therefore be coordinated with your overall tax situation.
5. Should I do Roth conversions before or after retirement?
   It depends primarily on your tax rates during each period. If you are in a high tax bracket while working and expect a substantially lower bracket immediately after retirement, waiting may be advantageous. If your income temporarily falls before retirement or future retirement income is expected to keep you in the same or a higher bracket, converting before retirement may deserve consideration.
6. Can a Roth conversion increase my Medicare premiums?
   Yes. A Roth conversion can increase modified adjusted gross income and may cause higher Medicare Part B and Part D premiums through IRMAA. Medicare generally uses tax-return information from two years earlier when determining these income-related adjustments. However, reducing pre-tax retirement balances through conversions could potentially reduce future required minimum distributions and taxable income, so both the short- and long-term Medicare effects should be considered.
7. Are Roth conversions taxable in New York State?
   Roth conversion income can be subject to New York income tax, but qualifying taxpayers age 59 1/2 or older may be eligible for New York's pension and annuity income exclusion of up to $20,000 per taxpayer. Married taxpayers can potentially each qualify for their own exclusion if each has qualifying income. Other pension income can also use the exclusion, so the full $20,000 may not always be available for a Roth conversion.
8. Should I pay Roth conversion taxes from my IRA or from cash?
   When possible and appropriate, paying the conversion tax from cash or other non-retirement assets can allow more of the retirement money to reach the Roth IRA. This can be especially important before age 59 1/2 because money distributed from an IRA for taxes rather than converted may be subject to the additional 10% early-distribution tax unless an exception applies. Even after age 59 1/2, withholding from the IRA reduces the amount transferred to the Roth.
9. Can an expected inheritance affect whether I should do Roth conversions?
   Yes. If you reasonably expect to inherit substantial traditional retirement accounts, future taxable distributions from those inherited accounts could increase your retirement income and potentially your marginal tax rate. Many non-spouse beneficiaries are subject to a 10-year distribution period under current federal rules. However, because the timing and amount of an inheritance are uncertain, it generally makes sense to model multiple scenarios rather than basing your entire Roth conversion strategy on an expected inheritance.
10. What time of year is best for a Roth conversion?
    Later in the year can be useful because you generally have a clearer picture of your salary, bonuses, business income, capital gains, and other taxable income. November or early December may provide enough information to estimate an appropriate conversion amount while still allowing time for the financial institution to process the transaction. Avoid waiting until the final days of December because custodians may have earlier year-end processing deadlines.

The Rules for Spousal IRA Contributions

By Michael Ruger, CFP®
Partner and Chief Investment Officer at Greenbush Financial Group

One of the basic requirements for contributing to an IRA is having earned income, or what the IRS generally refers to as taxable compensation. But what happens when one spouse works and the other spouse does not?

Many married couples assume that the non-working spouse cannot contribute to an IRA because that spouse does not have earned income of their own. Fortunately, that is not always the case. The spousal IRA contribution rules can allow a married couple filing a joint tax return to use the compensation earned by one spouse to support IRA contributions for both spouses.

This can be particularly valuable when one spouse leaves the workforce to raise children, care for a family member, attend school, or simply because the household is supported by one income. Instead of losing years of potential retirement savings, the couple may be able to continue funding an IRA for the non-working spouse.

In this article, we will cover:

• How spousal IRA contributions work

• The 2026 spousal Roth IRA contribution rules

• The 2026 traditional IRA deduction limits for married couples

• How workplace retirement plans can change the traditional IRA deduction

• Common mistakes that can result in excess contributions, taxes, or penalties

• How the backdoor Roth IRA strategy can interact with spousal IRA contributions

What Is a Spousal IRA Contribution?

The term “spousal IRA” can be a little misleading because there is not actually a special account called a spousal IRA. The account is simply a traditional IRA or Roth IRA owned by the spouse.

Normally, an individual's IRA contributions cannot exceed that individual's taxable compensation for the year. However, special rules apply to married couples who file a joint federal income tax return. If one spouse has little or no taxable compensation, the couple may still be able to contribute to an IRA for that spouse based on the compensation earned by the other spouse.

It is helpful to think of this as a special contribution rule rather than literally transferring or assigning income from one spouse to the other. Each spouse must have their own IRA, and each spouse is subject to the applicable annual IRA contribution limit. You cannot put both spouses' contributions into a single IRA.

For 2026, the IRA contribution limit is $7,500 per person. Individuals age 50 or older can contribute an additional $1,100 catch-up contribution, bringing their 2026 limit to $8,600. These limits apply across an individual's traditional and Roth IRAs combined.

This means that, assuming sufficient compensation and all other requirements are satisfied, a married couple under age 50 could potentially contribute a combined $15,000 to IRAs for 2026, even if only one spouse works.

Spousal Roth IRA Contributions in 2026

For many married couples, the Roth IRA is the easiest place to begin the spousal IRA discussion.

Roth IRA contributions are made with after-tax dollars. There is no immediate income tax deduction for making the contribution, but qualified distributions from a Roth IRA can generally be received tax-free in retirement.

There is one major hurdle: Roth IRA contributions are subject to income limitations.

For 2026, married couples filing jointly are subject to the following Roth IRA modified adjusted gross income, or MAGI, limits:

As long as the couple meets the applicable income and compensation requirements, the fact that one spouse does not work does not automatically prevent that spouse from funding a Roth IRA.

Example: Scott and Tina

Assume Scott and Tina are married and file their tax return jointly. Scott earns $150,000 per year, while Tina does not currently work. Both are under age 50.

Because their income is below the 2026 Roth IRA income phaseout range and Scott has sufficient compensation, Scott could contribute $7,500 to his Roth IRA, and the couple could also contribute $7,500 to Tina's Roth IRA under the spousal IRA rules.

Their total Roth IRA contributions for the year would be $15,000.

This is an important planning opportunity. Without the spousal IRA rules, a couple might incorrectly assume that Tina has to wait until she returns to work before she can begin saving in an IRA again. Instead, she can potentially continue accumulating retirement assets in an account in her own name.

Over a period of many years, those additional contributions and the investment growth on those contributions can become significant.

The Couple Must Have Enough Compensation

The Roth IRA income limit is not the only number that matters. The couple also needs enough eligible compensation to support their combined IRA contributions.

For example, assume a married couple under age 50 has only $10,000 of eligible compensation for the year. They generally cannot contribute $7,500 to one spouse's IRA and another $7,500 to the other spouse's IRA simply because the individual IRA limit is $7,500. Their available compensation is not sufficient to support $15,000 of combined contributions.

This distinction can become important when a spouse works only part of the year, retires during the year, or has income that does not qualify as compensation for IRA purposes.

Investment income, interest, dividends, pension income, and many other forms of income are not treated the same as wages or self-employment earnings for purposes of determining IRA contribution eligibility. Before making a spousal IRA contribution, it is important to verify that the household has sufficient qualifying compensation.

Traditional Spousal IRA Contributions Are More Complicated

Traditional IRA contributions require another layer of analysis.

The first question is whether the couple is eligible to make the IRA contribution. The second—and separate—question is whether the contribution is deductible for income tax purposes.

These two questions are frequently confused.

A married couple may have enough compensation to make traditional IRA contributions for both spouses but still discover that some or all of the contributions are not deductible because of their income and participation in an employer-sponsored retirement plan.

For purposes of determining the traditional IRA deduction, you need to know whether each spouse is covered by a retirement plan at work.

2026 Traditional IRA Deduction Limits When the Contributor Is Covered by 401(k) or 403(b)

Assume a married couple files jointly and the spouse making the traditional IRA contribution is covered by an employer-sponsored retirement plan, such as a 401(k) or 403(b).

For 2026, the traditional IRA deduction phaseout for a married couple filing jointly when the IRA contributor is covered by a workplace retirement plan is:

Now consider the spouse who is not covered by a retirement plan at work.  If that spouse is married to someone who is covered by a workplace retirement plan, a different—and much higher—income phaseout applies.

2026 Traditional IRA Deduction Limits for the Spouse Who Is Not Covered by 401(k) or 403(b)

For a married couple filing jointly, when the IRA contributor is not covered by a workplace retirement plan but their spouse is, the 2026 deduction limits are:

The important point is that each spouse's workplace retirement plan coverage matters separately.

A couple should not simply look at their household income and assume that the same traditional IRA deduction limit applies to both spouses. One spouse could potentially be prohibited from deducting a traditional IRA contribution while the other spouse remains eligible for a full deduction.

The IRS specifically provides the higher $242,000–$252,000 phaseout range for 2026 when the IRA contributor is not covered by a workplace plan but is married to someone who is.

Example: One Spouse Is Covered by a 401(k)

Assume Scott and Tina file jointly and have modified AGI of $160,000. Scott works and participates in his employer's 401(k), while Tina does not work and is not covered by an employer-sponsored retirement plan.

Scott may have enough earned income to support IRA contributions for both himself and Tina. However, that does not mean their traditional IRA contributions receive identical tax treatment.

Because Scott is covered by a workplace retirement plan and their modified AGI exceeds $149,000, Scott would generally not be entitled to a traditional IRA deduction under the 2026 limits.

Tina is treated differently.

She is not covered by a workplace retirement plan. Because she is married to someone who is covered, her traditional IRA deduction is instead subject to the $242,000–$252,000 phaseout range. At $160,000 of modified AGI, she could potentially make a traditional IRA contribution and receive a full deduction, assuming the other requirements are satisfied.

Same household. Same income. Two very different IRA deduction results.

What If Neither Spouse Is Covered by a Retirement Plan at Work?

This is another important distinction.

If neither spouse is covered by a retirement plan at work, the income-based traditional IRA deduction phaseouts discussed above generally do not apply. Assuming the couple otherwise qualifies, their traditional IRA contributions can generally be deductible regardless of their income.

This is why it is important not to automatically associate a high income with an inability to deduct a traditional IRA contribution. Whether the taxpayer or their spouse is covered by a workplace retirement plan is a critical part of the analysis.

Making the Contribution and Deducting the Contribution Are Two Different Tests

This concept is worth emphasizing because it is the source of many IRA mistakes.

When evaluating a traditional IRA contribution, think of the process as two separate tests.

Test #1: Can you contribute?

The couple needs to satisfy the rules for making an IRA contribution, including having sufficient qualifying compensation and, for a spousal IRA contribution, generally filing a joint return.

Test #2: Can you deduct it?

Once you establish that the contribution can be made, you then determine whether it is fully deductible, partially deductible, or nondeductible. This calculation depends in part on modified AGI and whether the individual making the contribution—or that individual's spouse—is covered by a workplace retirement plan.

Failing the deduction test does not necessarily mean that the taxpayer cannot contribute to a traditional IRA. It may simply mean the contribution is nondeductible.  That distinction leads us to another potential strategy: the backdoor Roth IRA.

Spousal IRA Contributions and the Backdoor Roth IRA

What happens when a married couple earns too much to contribute directly to Roth IRAs and also earns too much to deduct their traditional IRA contributions?

This is where the backdoor Roth IRA strategy may become relevant.

For 2026, married couples filing jointly begin losing their ability to contribute directly to Roth IRAs when modified AGI reaches $242,000, and direct contributions are eliminated at $252,000. However, Roth conversions do not have the same income restriction.

As a result, an individual may be able to:

1. Make a nondeductible contribution to a traditional IRA.

2. Convert the traditional IRA to a Roth IRA.

3. Properly report the nondeductible contribution and Roth conversion on their tax return.

However, there is an important trap: the pro-rata rule.

Watch Out for the Pro-Rata Rule

A backdoor Roth IRA is not automatically tax-free simply because the original traditional IRA contribution was nondeductible.

If an individual already has pre-tax money in traditional IRAs, SEP IRAs, or SIMPLE IRAs, the IRS generally looks at the individual's aggregate applicable IRA balances when determining the taxable and nontaxable portions of a Roth conversion. You generally cannot isolate only the after-tax dollars and convert those dollars while leaving all of the pre-tax IRA money untouched.

For married couples, there is an especially important distinction: the pro-rata calculation is generally determined separately for each spouse.

For example, assume Scott has a $300,000 rollover traditional IRA containing pre-tax money, while Tina has no traditional, SEP, or SIMPLE IRA balances. Scott's existing IRA could create a significant pro-rata issue for his own backdoor Roth strategy. It does not automatically contaminate Tina's backdoor Roth transaction simply because they are married and file jointly.

Each spouse owns their IRA individually.

That can create valuable planning opportunities, but it also makes careful tax reporting extremely important. Nondeductible traditional IRA contributions are generally reported on IRS Form 8606, which tracks the individual's after-tax basis in traditional IRAs.

Common Spousal IRA Contribution Mistakes

Spousal IRA contributions can be straightforward when the rules are followed, but several mistakes can create unwanted tax consequences.

One common mistake is assuming that a non-working spouse cannot contribute at all. Another is making the maximum contribution for both spouses without first confirming that the couple has enough qualifying compensation to support the contributions. Couples can also mistakenly make direct Roth IRA contributions before realizing that their year-end modified AGI exceeds the applicable Roth IRA income limit.

Traditional IRAs introduce additional opportunities for mistakes. A couple might assume a contribution is deductible without checking workplace retirement plan coverage, or they may make a nondeductible contribution but fail to properly report the basis on Form 8606. With a backdoor Roth IRA, overlooking existing pre-tax traditional, SEP, or SIMPLE IRA balances can result in a larger taxable conversion than anticipated.

If too much is contributed to an IRA, an excess contribution may need to be corrected. If it is not handled properly and within the applicable deadlines, additional taxes or penalties may apply.  This is one reason year-end IRA planning should involve more than simply asking, “How much can we contribute?”

The better questions are: How much can we contribute, where should each spouse contribute it, is the contribution deductible, are we eligible for a Roth IRA, and will any existing IRA balances affect a Roth conversion?

Why Spousal IRA Contributions Can Be So Valuable

It is easy to overlook retirement savings for a spouse who temporarily or permanently leaves the workforce.   But retirement is usually a household goal.

If a married couple can afford to save $15,000 instead of $7,500 in 2026, using the spousal IRA rules could substantially increase the amount accumulated for retirement over time. Just as importantly, the non-working spouse is building retirement assets in an account legally owned in their own name.

Consider a spouse who remains out of the workforce for ten years while raising children. If the family ignores the spousal IRA rules, that could potentially represent ten years of missed IRA contributions and investment growth.  The spousal IRA rules can help close that retirement savings gap.

About Michael……...

Hi, I’m Michael Ruger. I’m the managing partner of Greenbush Financial Group and the creator of the nationally recognized Money Smart Board blog . I created the blog because there are a lot of events in life that require important financial decisions. The goal is to help our readers avoid big financial missteps, discover financial solutions that they were not aware of, and to optimize their financial future.

Frequently Asked Questions About Spousal IRA Contributions

1. Can I contribute to an IRA if I do not work but my spouse does?
   Potentially, yes. If you are married, file a joint federal income tax return, and your spouse has sufficient qualifying compensation, the spousal IRA rules may allow a contribution to an IRA in your name even if you have little or no compensation of your own.
2. What is the spousal IRA contribution limit for 2026?
   The 2026 IRA contribution limit is $7,500 per individual. If you are age 50 or older, the limit is $8,600 because of the additional $1,100 catch-up contribution. The limit applies to each individual's traditional and Roth IRA contributions combined.
3. Can a non-working spouse contribute to a Roth IRA in 2026?
   Yes, assuming the couple satisfies the spousal IRA requirements and the Roth IRA income limitations. For married couples filing jointly in 2026, the Roth IRA contribution phaseout occurs between $242,000 and $252,000 of modified AGI. At $252,000 or more, a direct Roth IRA contribution is generally not permitted.
4. Do spousal IRA contributions have to go into a special spousal IRA account?
   No. A "spousal IRA" is not a separate type of retirement account. The contribution is made to a traditional IRA or Roth IRA owned by the spouse. IRAs are individual accounts, so each spouse needs their own IRA.
5. Do married couples have to file jointly to make a spousal IRA contribution?
   Generally, yes. The special spousal IRA contribution rules allowing one spouse's compensation to support the other spouse's IRA contribution apply to married couples filing a joint return. Filing status is therefore an important consideration before assuming a non-working spouse is eligible to contribute.
6. Is a spousal traditional IRA contribution always tax-deductible?
   No. Eligibility to contribute and eligibility to claim a deduction are separate issues. If either spouse participates in an employer-sponsored retirement plan, modified AGI can limit or eliminate the traditional IRA deduction. In 2026, the phaseout is $129,000-$149,000 for a married-filing-jointly IRA contributor who is covered at work, while a contributor who is not covered but whose spouse is covered has a $242,000-$252,000 phaseout range.
7. Can I make a traditional IRA contribution if my income is too high to deduct it?
   Potentially, yes. Income can prevent a traditional IRA contribution from being deductible without necessarily preventing the contribution itself. In that situation, the contribution may be treated as nondeductible and should generally be reported appropriately on Form 8606.
8. Can both spouses do a backdoor Roth IRA?
   Potentially. If direct Roth IRA contributions are unavailable because of income, each spouse may be able to make a nondeductible traditional IRA contribution and subsequently convert it to a Roth IRA. However, the tax consequences should be evaluated separately for each spouse, particularly if either spouse owns pre-tax traditional, SEP, or SIMPLE IRA assets.
9. Does my spouse's traditional IRA create a pro-rata problem for my backdoor Roth IRA?
   Generally, the pro-rata calculation is applied at the individual level rather than combining both spouses' IRA balances. If one spouse has a large pre-tax traditional IRA and the other has no pre-tax IRA assets, their backdoor Roth tax consequences may therefore be very different even though they file a joint tax return.
10. What happens if we make an IRA contribution and later discover we were not eligible?
    An ineligible contribution may be considered an excess IRA contribution and should not simply be ignored. Depending on the circumstances and timing, there may be methods available to correct the contribution, but failure to correct an excess contribution can result in additional taxes or penalties. If your income is close to a Roth IRA phaseout limit or your compensation is uncertain, consider reviewing your eligibility with a tax professional before the applicable correction deadlines.

Common Backdoor Roth IRA Mistakes

By Michael Ruger, CFP®
Partner and Chief Investment Officer at Greenbush Financial Group

The Backdoor Roth IRA strategy has become increasingly common among higher-income individuals who earn too much to make a direct contribution to a Roth IRA. The concept sounds relatively simple: make a nondeductible contribution to a Traditional IRA and then convert that money to a Roth IRA. Because there is no income limitation on Roth IRA conversions, this strategy can potentially allow higher-income taxpayers to continue building Roth assets even when their income prevents them from contributing directly to a Roth IRA.

However, simple does not always mean easy. We are seeing a growing number of mistakes in the execution of Backdoor Roth IRA strategies, and some of those mistakes can create unexpected taxable income, additional tax filings, and other complications.

In this article, we will cover some of the most common Backdoor Roth IRA mistakes, including:

• How the Backdoor Roth IRA strategy works for high-income earners

• How the Backdoor Roth IRA aggregation rule can create unexpected taxes

• Why Traditional IRA, Rollover IRA, SEP IRA, and SIMPLE IRA balances can affect a Roth conversion

• What investors should know about the Backdoor Roth IRA step-transaction rule

• Why a Roth 401(k) does not prevent you from completing a Backdoor Roth IRA

• Why IRS Form 8606 is critical when making nondeductible IRA contributions

• How investment gains before a Roth conversion can create taxable income

• How to avoid common Backdoor Roth IRA tax mistakes before executing the strategy

Understanding these rules before you move any money can make a significant difference. A Backdoor Roth IRA can be a powerful retirement planning strategy, but the tax treatment depends heavily on how the transaction is executed.

What Is a Backdoor Roth IRA?

A Backdoor Roth IRA is not a special type of retirement account. It is simply a strategy that generally involves making a nondeductible contribution to a Traditional IRA and then converting those assets to a Roth IRA. The strategy is primarily used by individuals whose income is too high to make a direct Roth IRA contribution.

For 2026, the Roth IRA contribution phaseout range is $153,000 to $168,000 for single filers and heads of household and $242,000 to $252,000 for married couples filing jointly. The 2026 IRA contribution limit is $7,500 for individuals under age 50 and $8,600 for individuals age 50 or older. While there are income limits that determine whether you can contribute directly to a Roth IRA, there is no similar income limitation that prevents an individual from converting Traditional IRA assets to a Roth IRA.

That difference is what makes the Backdoor Roth IRA strategy possible. Instead of contributing directly to a Roth IRA, the individual contributes after-tax money to a Traditional IRA and later converts that money to a Roth IRA. If the strategy is properly executed and the individual has no other pre-tax IRA money, the tax consequences of the conversion may be minimal or potentially zero.

Mistake #1: Ignoring the IRA Aggregation and Pro-Rata Rule

The IRA aggregation rule, also commonly called the pro-rata rule, is probably the most important Backdoor Roth IRA mistake to understand. Many investors assume that if they open a brand-new Traditional IRA, contribute after-tax money to that account, and convert only that account to a Roth IRA, the conversion will automatically be tax-free. Unfortunately, that is not always how the tax calculation works.

For purposes of determining how much of an IRA conversion is taxable versus nontaxable, the IRS generally does not allow you to isolate your nondeductible contribution from your other Traditional IRA money. Instead, applicable Traditional IRA balances are aggregated together when determining what percentage of the conversion represents pre-tax money and what percentage represents after-tax basis. This generally includes Traditional IRAs, Rollover IRAs, Traditional SEP IRAs, and Traditional SIMPLE IRAs.

A Simple $100,000 Backdoor Roth IRA Example

Assume John already has a Traditional IRA worth $95,000, and all $95,000 is pre-tax money. John then opens a separate Traditional IRA, contributes $5,000 to it, and does not take a tax deduction for that contribution. A few days later, he converts the entire $5,000 from the new Traditional IRA into his Roth IRA.

John may assume that because he contributed $5,000 of after-tax money and converted that same $5,000, the conversion should be tax-free. However, when the aggregation rule is applied, John effectively has $100,000 of total IRA money for purposes of this simplified example: $95,000 of pre-tax money and $5,000 of after-tax basis.

In this example, only 5% of John's IRA money represents after-tax basis, while 95% represents pre-tax money. Therefore, approximately 95% of the $5,000 Roth conversion would be taxable, or roughly $4,750. Only about $250 of the conversion would represent a nontaxable recovery of basis.

This is where many individuals get surprised. They believed they completed a tax-free $5,000 conversion, but because of the other pre-tax IRA assets, most of the conversion becomes taxable.

Opening a Separate IRA Does Not Avoid the Aggregation Rule

Another common misconception is that the aggregation rule can be avoided simply by opening a separate IRA at another financial institution. For example, someone may have a $500,000 Rollover IRA at one investment company and decide to open a brand-new Traditional IRA somewhere else specifically for the Backdoor Roth IRA strategy. Unfortunately, keeping the accounts physically separate does not necessarily separate them for tax purposes.

The same issue applies if one account is labeled a "Backdoor Roth IRA account." The IRS is generally looking at the applicable IRA balances collectively when determining the taxable portion of a distribution or conversion. Before executing a Backdoor Roth IRA, it is important to identify all existing Traditional, Rollover, SEP, and SIMPLE IRA balances that could potentially affect the calculation.

What About Money in a 401(k)?

A 401(k) is treated differently from an IRA for purposes of the Backdoor Roth aggregation calculation. Simply having a large balance in a current employer's 401(k) does not by itself create the same pro-rata problem. For example, an individual could have $800,000 in a pre-tax 401(k), no Traditional IRA balances, and still potentially execute a relatively clean Backdoor Roth IRA strategy.

This distinction can sometimes create planning opportunities. In certain situations, an employer's 401(k) may accept a rollover of pre-tax IRA assets, which could potentially move those assets out of the IRA aggregation calculation before year-end. However, that decision should not be made solely for tax convenience because investment choices, fees, creditor protections, withdrawal provisions, and other plan features should also be considered.

Mistake #2: Misunderstanding the Step-Transaction Concern

The second major issue surrounding Backdoor Roth IRAs involves what is commonly called the step-transaction doctrine. Very generally, this is a tax principle under which a series of formally separate transactions may, under certain circumstances, be viewed together based on their substance. Historically, this created concern that making a nondeductible Traditional IRA contribution and immediately converting it to a Roth IRA could potentially be viewed as an indirect way of making a Roth contribution that the individual was not otherwise eligible to make directly.

That concern has led to a lot of informal advice over the years suggesting that taxpayers should wait some period of time between making the nondeductible IRA contribution and completing the Roth conversion. You may hear recommendations to wait 30 days, 60 days, or 90 days. The important point is that there is no specific IRS safe harbor stating that waiting a particular number of days makes the strategy automatically protected from the step-transaction doctrine.

Current IRS guidance recognizes both nondeductible Traditional IRA contributions and Roth IRA conversions, and Roth conversions are not subject to the same income limits that apply to direct Roth IRA contributions. Therefore, we would be careful about presenting any specific waiting period as an IRS requirement. If you have concerns about how the step-transaction doctrine could apply to your specific situation, that is an issue to discuss with your CPA or tax attorney.

Waiting Can Create Another Backdoor Roth IRA Issue

There is another reason why blindly waiting 60 or 90 days is not necessarily the perfect solution. If the money inside the Traditional IRA is invested during that waiting period, the account could increase in value before the Roth conversion occurs. Those investment gains may create taxable income when the money is eventually converted.

For example, assume you make a $7,500 nondeductible contribution to a Traditional IRA and invest the money immediately. Over the next 90 days, the account grows to $7,900. If you then convert the entire $7,900 to the Roth IRA and you have no other IRA balances or basis, you generally have only $7,500 of after-tax basis, meaning the additional $400 of investment growth may be taxable.

This does not necessarily make the Backdoor Roth IRA strategy unsuccessful. Paying tax on a few hundred dollars of gains may be relatively minor. However, it is another reason why the timing of the contribution, investment, and conversion should be intentional rather than based on an assumed 60- or 90-day IRS requirement.

Mistake #3: Thinking a Roth 401(k) Prevents a Backdoor Roth IRA

Another common misconception is that someone who is already contributing to a Roth 401(k) cannot also execute a Backdoor Roth IRA strategy. That is not the case. Roth 401(k) contributions and IRA contributions are governed by separate annual contribution limits.

For example, assume a 45-year-old high-income employee is maxing out their Roth 401(k). For 2026, that individual could potentially contribute $24,500 to the Roth 401(k) and separately make a $7,500 nondeductible contribution to a Traditional IRA, followed by a Roth conversion, assuming the strategy is otherwise appropriate. The fact that both strategies involve Roth accounts does not cause the limits to overlap.

This can be especially valuable for higher-income households that are trying to accumulate more tax-free retirement assets. Someone who is already maximizing Roth 401(k) contributions may still have the opportunity to add additional money to a Roth IRA through the Backdoor Roth IRA strategy.

Mistake #4: Forgetting to File Form 8606

Form 8606 is one of the most important pieces of paperwork associated with a Backdoor Roth IRA. When you make a nondeductible contribution to a Traditional IRA, you need a tax record establishing that you did not take a deduction for that contribution and that the money represents after-tax basis. Without proper documentation, it may become much more difficult to prove years later how much of your IRA has already been taxed.

The IRS uses Form 8606 to report nondeductible Traditional IRA contributions, certain IRA distributions when basis exists, and conversions from Traditional IRAs to Roth IRAs. In practical terms, Form 8606 helps prevent you from potentially paying tax twice on the same money. If you contribute $7,500 to a Traditional IRA and do not claim a deduction, you do not want that same $7,500 to be treated as fully taxable when it is later converted or distributed.

This is why properly filing Form 8606 is not simply a minor administrative step. It is part of keeping an accurate tax record of your after-tax IRA basis. Individuals who execute Backdoor Roth IRA strategies year after year should pay close attention to making sure Form 8606 is prepared correctly each year.

Mistake #5: Forgetting About an Old SEP IRA or SIMPLE IRA

One of the easiest mistakes to make is forgetting about an old retirement account from years ago. Someone may currently be a W-2 employee with no obvious Traditional IRA or Rollover IRA and assume that their Backdoor Roth IRA will be straightforward. However, they may have opened a SEP IRA or SIMPLE IRA years earlier when they were self-employed or worked for a different company.

If that account still contains pre-tax money, it may affect the pro-rata calculation. For example, an old $80,000 SEP IRA sitting at another custodian may suddenly become very relevant when determining how much of a current Roth conversion is taxable.

This is why we recommend completing a retirement-account inventory before implementing the strategy. Do not simply ask whether you have a Traditional IRA. Ask whether you have any Traditional, Rollover, SEP, or SIMPLE IRA balances that could impact the calculation.

Mistake #6: Confusing the IRA Contribution Limit With the Roth Conversion Limit

Another common misunderstanding is assuming that if the annual IRA contribution limit is $7,500, then the maximum Roth conversion is also $7,500. Those are two completely different rules. The annual contribution limit determines how much new money can be contributed to an IRA, while a Roth conversion involves moving existing Traditional IRA assets into a Roth IRA.

For example, someone could make a $7,500 nondeductible Traditional IRA contribution and separately decide to convert $100,000 of existing pre-tax IRA assets to a Roth IRA. There is no general $7,500 annual limit on Roth conversions. However, converting pre-tax retirement assets to a Roth IRA generally creates taxable income, which means large conversions require careful tax planning.

This distinction is important because the Backdoor Roth IRA strategy involves both a contribution and a conversion. The contribution limit applies to the first step. The tax consequences of the conversion depend on the character of the money being converted and the individual's overall IRA situation.

A Backdoor Roth IRA Pre-Flight Checklist

Before executing a Backdoor Roth IRA, it can help to work through a short checklist. A few minutes spent reviewing your accounts before making the contribution or conversion can potentially prevent an unpleasant surprise when your tax return is prepared.

• Am I above the income limit for making a direct Roth IRA contribution?

• How much am I eligible to contribute to an IRA this year?

• Do I have any Traditional IRAs or Rollover IRAs?

• Do I have a SEP IRA or SIMPLE IRA?

• Do I have existing nondeductible IRA basis from prior years?

• Have I reviewed the Backdoor Roth IRA pro-rata calculation before converting?

• Could investment gains occur before the Roth conversion?

• Will IRS Form 8606 be properly prepared with my tax return?

• Does my employer's 401(k) accept incoming IRA rollovers?

• Should I review the strategy with my CPA before completing the transaction?

The more complicated your retirement-account history is, the more important this review becomes. A forgotten Rollover IRA or old SEP IRA can materially change the tax result of a Backdoor Roth IRA conversion.

The Backdoor Roth IRA Can Still Be a Powerful Strategy

None of these potential mistakes mean that investors should avoid Backdoor Roth IRAs. For the right individual, the strategy can be an excellent way to accumulate Roth assets when income prevents a direct Roth IRA contribution. Once assets are successfully inside a Roth IRA, they have the potential to grow tax-deferred, and qualified Roth IRA distributions can ultimately be tax-free.

The biggest issue is not necessarily choosing the wrong investment. It is assuming the transaction is simpler than it actually is. Before making the contribution, understand the aggregation rule; before making the conversion, understand what portion may be taxable; and after completing the transaction, make sure the tax reporting is handled properly.

The Backdoor Roth IRA strategy is often described as a simple two-step process: make a nondeductible Traditional IRA contribution and then convert it to a Roth IRA. In reality, several important tax rules sit underneath those two steps. The goal is not simply to get money into the Roth IRA—it is to get the money into the Roth IRA correctly.

About Michael……...

Hi, I’m Michael Ruger. I’m the managing partner of Greenbush Financial Group and the creator of the nationally recognized Money Smart Board blog . I created the blog because there are a lot of events in life that require important financial decisions. The goal is to help our readers avoid big financial missteps, discover financial solutions that they were not aware of, and to optimize their financial future.

Frequently Asked Questions About Backdoor Roth IRAs

1. 1. What is a Backdoor Roth IRA?
   A Backdoor Roth IRA is a strategy commonly used by higher-income individuals who are not eligible to contribute directly to a Roth IRA. The strategy generally involves making a nondeductible contribution to a Traditional IRA and then converting those assets to a Roth IRA. It is not a separate type of retirement account; it is simply a series of transactions using existing IRA rules.
2. 2. Is a Backdoor Roth IRA legal?
   Backdoor Roth IRA strategies use existing rules that allow nondeductible Traditional IRA contributions and Roth IRA conversions. There is no income limit on Roth conversions, even though income limits apply to direct Roth IRA contributions. However, the tax consequences can become complicated when an individual has other pre-tax IRA assets, so proper execution and reporting are important.
3. 3. What is the Backdoor Roth IRA pro-rata rule?
   The Backdoor Roth IRA pro-rata rule determines how much of a Roth conversion is taxable when you have both pre-tax and after-tax money in your applicable IRAs. You generally cannot choose to convert only the after-tax dollars while leaving all of the pre-tax money untouched for tax purposes. Instead, the taxable and nontaxable portions are determined proportionately based on your overall IRA balances and basis.
4. 4. Which IRA accounts are included in the Backdoor Roth IRA aggregation rule?
   Traditional IRAs, Rollover IRAs, Traditional SEP IRAs, and Traditional SIMPLE IRAs generally need to be considered when calculating the taxable portion of an IRA distribution or Roth conversion. Keeping these accounts at different financial institutions does not necessarily allow you to avoid the aggregation rule. This is why identifying all of your IRA balances before executing a Backdoor Roth IRA is so important.
5. 5. Does a 401(k) count toward the Backdoor Roth IRA pro-rata rule?
   Generally, assets held inside a 401(k) are not included in the IRA aggregation calculation simply because they are pre-tax retirement assets. This can be an important distinction for individuals with large 401(k) balances but no pre-tax Traditional, Rollover, SEP, or SIMPLE IRA assets. In some situations, rolling eligible IRA assets into an employer 401(k) that accepts incoming rollovers may also help with future Backdoor Roth IRA planning.
6. 6. How long should I wait between a Traditional IRA contribution and Roth conversion?
   There is no specific IRS rule establishing a required 30-day, 60-day, or 90-day waiting period between a nondeductible Traditional IRA contribution and a Roth conversion. Although the step-transaction doctrine has historically generated discussion around Backdoor Roth IRA timing, no specific waiting period creates an automatic safe harbor. Individuals concerned about how the doctrine may apply to their situation should consult a tax professional.
7. 7. Can I do a Backdoor Roth IRA if I already contribute to a Roth 401(k)?
   Yes. Roth 401(k) contributions and IRA contributions are subject to separate annual contribution limits. An individual may potentially maximize Roth 401(k) salary deferrals and separately make a nondeductible Traditional IRA contribution followed by a Roth conversion, assuming the individual otherwise qualifies and the strategy is appropriate.
8. 8. Do I need to file Form 8606 for a Backdoor Roth IRA?
   Form 8606 is generally an important part of reporting a Backdoor Roth IRA because it tracks nondeductible Traditional IRA contributions and after-tax IRA basis. It is also used in reporting Roth conversions. Properly tracking basis helps prevent after-tax IRA money from potentially being taxed again when it is converted or later distributed.
9. 9. Do I owe taxes on a Backdoor Roth IRA conversion?
   You may owe taxes on a Backdoor Roth IRA conversion depending on your other IRA balances and whether the contribution generated earnings before the conversion. If you have no other pre-tax IRA assets and convert a nondeductible contribution before significant gains occur, the taxable amount may be small or potentially zero. If you have substantial pre-tax Traditional, Rollover, SEP, or SIMPLE IRA balances, however, the pro-rata rule can cause a large portion of the conversion to become taxable.
10. 10. Can I do a Backdoor Roth IRA every year?
    Potentially, yes. Individuals who continue to meet the requirements for making an IRA contribution may be able to repeat the Backdoor Roth IRA strategy in multiple years. However, the pro-rata rule, IRA balances, contribution limits, tax laws, and reporting requirements should be reviewed each year because a strategy that worked cleanly one year may have different tax consequences in a later year.

How Long Does It Take to Build a $1 Million Roth IRA?

By Michael Ruger, CFP®
Partner and Chief Investment Officer at Greenbush Financial Group

The Roth IRA may be one of the most powerful retirement savings vehicles available. Why? Because it combines the power of compound investment returns with the potential for tax-free retirement income.

With a Roth IRA, you contribute money that has already been taxed. Once the money is inside the account, your investments can grow without annual taxation on interest, dividends, or capital gains. Even better, qualified withdrawals can be completely tax-free in retirement. Generally, for earnings to be withdrawn tax-free, the Roth IRA must satisfy the five-year requirement and the distribution must occur after age 59½ or meet another qualifying condition.

That combination can make a Roth IRA doubly powerful: your investment returns compound over time, and those compounded returns may ultimately be withdrawn tax-free.

In this article, we will look at:

• How long it could take a 22-year-old to build a $1 million Roth IRA

• How much of that $1 million comes from contributions versus investment growth

• Why reaching your first $1 million can be such an important milestone

• How the Rule of 72 demonstrates the power of additional compounding cycles

• Why starting early can have such a dramatic impact on your long-term wealth

How Does a Roth IRA Grow?

A Roth IRA is an account, not an investment itself. Within the Roth IRA, you can typically invest in stocks, bonds, mutual funds, ETFs, and other investments.

The investments you select will determine how quickly the account grows.

Unlike a taxable investment account, however, you generally do not have to pay taxes each year on investment activity occurring inside the Roth IRA. That allows the entire account balance to remain invested and continue compounding.

How Long Does It Take to Build a $1 Million Roth IRA?

Let's look at a hypothetical 22-year-old investor.

For 2026, the IRA contribution limit is $7,500 for an individual under age 50, assuming the individual has sufficient eligible compensation and qualifies to make the Roth IRA contribution. Roth IRA eligibility is also subject to income limitations.

For our example, let's assume:

Even though IRA contribution limits may increase in future years, we will assume the investor contributes exactly $7,500 every year to keep the example simple.  At an 8% annual rate of return, it would take approximately 32 years for the Roth IRA to cross the $1 million mark.  That means someone starting at age 22 could potentially become a Roth IRA millionaire around age 54.

But here's where the numbers become particularly interesting.  Over those 32 years, the investor would have personally contributed only:

$7,500 × 32 = $240,000

Yet the account would be worth approximately $1.02 million.  That means roughly $778,000 of the account value would be attributable to compounded investment growth, based on our hypothetical assumptions.  In other words, the investor contributed $240,000, but compounding did much of the heavy lifting.   And because the money is inside a Roth IRA, qualified distributions of those earnings could eventually be received tax-free.

Becoming a Roth IRA Millionaire Isn't the End of the Story

Reaching $1 million may sound like the finish line.  From a compounding standpoint, however, it may be closer to the beginning of the most powerful stage. Why?

Because once you've accumulated a large investment balance, you have a much larger amount of money generating potential investment returns.

An 8% return on a $50,000 portfolio is $4,000.

An 8% return on a $500,000 portfolio is $40,000.

An 8% return on a $1 million portfolio is $80,000.

The rate of return hasn't changed. What has changed is the amount of money working for you.  This is why building your first $1 million can be such an important milestone. Once you have accumulated that larger base, future compounding can potentially accelerate dramatically.

The Rule of 72: How Quickly Could $1 Million Become $2 Million?

There is a simple financial concept called the Rule of 72 that can help investors estimate how long it will take an investment to double. 

Take 72 and divide it by your assumed annual rate of return.

At an 8% annual return:

72 ÷ 8 = 9 years

So, according to the Rule of 72, an investment earning approximately 8% per year would double about every nine years. Now apply that concept to our Roth IRA millionaire.

Suppose our hypothetical investor reaches approximately $1 million around age 54. From that point forward, let's assume they never contribute another dollar and the account continues earning a hypothetical average return of 8%.

The potential growth looks something like this:

Notice what's happening.

It took roughly 32 years of annual contributions to accumulate the first $1 million.

But the next $1 million could potentially be created in only about nine additional years—with no additional contributions at all. Then $2 million could become $4 million approximately nine years later.  That's the power of compounding cycles.

Most of the Potential Wealth Can Be Created Later

One of the hardest concepts for younger investors to appreciate is that the early years of investing can sometimes feel painfully slow.

You contribute $7,500.  Then another $7,500.  Then another.  You may look at your account after several years and wonder why the balance isn't growing faster.  But those early contributions are building the foundation that allows compounding to become much more powerful later.

Consider our hypothetical doubling cycle:

$1 million → $2 million: $1 million of additional growth

$2 million → $4 million: $2 million of additional growth

$4 million → $8 million: $4 million of additional growth

The percentage return didn't change. We continued to assume 8%.  But the dollar amount of growth became substantially larger with each doubling cycle.  This illustrates an important wealth-building principle:

The sooner you can accumulate your first meaningful pool of investment assets, the more potential compounding cycles you may have available later in life.

Why Starting at Age 22 Can Be So Powerful

Young investors often believe they don't have enough money for investing to make a meaningful difference.  But when you're young, you have an asset that someone approaching retirement cannot buy: Time

A dollar invested at age 22 potentially has decades to compound.  A dollar invested at age 52 simply doesn't have the same runway before retirement.  This doesn't mean someone who didn't start investing in their 20s has missed their opportunity. The best strategy is generally to begin when you are financially able to do so and build from there. 

But for younger investors, understanding the value of starting early can be incredibly important.  Your first few Roth IRA contributions may not seem life-changing when you make them.  Thirty or forty years of compounding may tell a very different story.

The Tax-Free Compounding Advantage of a Roth IRA

There is another important piece to this example.

If you accumulate $1 million in a traditional pre-tax retirement account, that $1 million isn't necessarily the same as having $1 million available to spend. Withdrawals from traditional retirement accounts are generally subject to ordinary income tax.

A Roth IRA works differently.  Contributions are made with after-tax dollars, so you don't receive an upfront tax deduction. In exchange, qualified Roth IRA withdrawals can be tax-free.  That means if our hypothetical Roth IRA eventually grows to $1 million, $2 million, or more, qualified distributions could potentially be received without federal income tax.

This is why we often think of Roth accounts as having two layers of compounding power:

1. Your investments have the opportunity to compound over time.

2. That compounded growth has the potential to ultimately be distributed tax-free.

For an investor with several decades before retirement, that combination can be extremely valuable.

Don't Forget About Roth IRA Income Limits

Before automatically contributing $7,500 to a Roth IRA, it is important to determine whether you are eligible.

Roth IRAs have income limitations.

For 2026, the Roth IRA contribution phase-out range is $153,000 to $168,000 for single filers and heads of household and $242,000 to $252,000 for married couples filing jointly.

Individuals above the applicable income limits may not be able to make a direct Roth IRA contribution. Depending on the individual's circumstances, other Roth strategies may be available, but those strategies have their own tax and planning considerations.

Key Takeaway

When you're young, your Roth IRA balance may seem small and the finish line may seem far away.  Don't underestimate what decades of consistent investing and compounding can potentially accomplish.  The goal isn't necessarily to get rich quickly.  The goal is to start the compounding clock as early as possible—and give it as much time as possible to work.

About Michael……...

Hi, I’m Michael Ruger. I’m the managing partner of Greenbush Financial Group and the creator of the nationally recognized Money Smart Board blog . I created the blog because there are a lot of events in life that require important financial decisions. The goal is to help our readers avoid big financial missteps, discover financial solutions that they were not aware of, and to optimize their financial future.

Rules for Inheriting a Retirement Account from a Sibling

By Michael Ruger, CFP®
Partner and Chief Investment Officer at Greenbush Financial Group

When you inherit a retirement account , whether it’s a 401(k), Traditional IRA, or Roth IRA, the rules depend heavily on who you inherited the account from. The rules for inheriting a retirement account from a sibling are very different from inheriting from a spouse, parent, or grandparent, and the distribution rules can have major tax consequences if not handled properly.

In this article, we’re going to walk through the key rules and planning strategies, including:

• The 10-year rule for inherited retirement accounts

• The age exception for siblings within 10 years

• Required Minimum Distribution (RMD) rules

• Tax strategies for inherited IRAs and 401(k)s

The 10-Year Rule

The IRS changed the rules for inherited retirement accounts starting in 2020 under the SECURE Act. For most non-spouse beneficiaries, inherited retirement accounts are now subject to the 10-year rule, which means the account must be fully depleted by the end of the 10th year following the year of death.

However, there is an important exception that often applies to siblings.

The Age Exception for Siblings

If you inherit a retirement account from a sibling and you are within 10 years of their age, you may qualify for the Eligible Designated Beneficiary exception. This allows you to use the old stretch IRA rules, instead of the 10-year rule.

This means:

• You are not required to empty the account within 10 years

• You are required to take annual RMDs based on your life expectancy

• The account can continue to grow tax-deferred over your lifetime

Example

Let’s say:

• Sue is age 50

• Brian is her brother, age 45

• Brian inherits Sue’s IRA

Because Brian is within 10 years of Sue’s age, he qualifies for the exception and can stretch distributions over his lifetime instead of following the 10-year rule.

He must begin taking Required Minimum Distributions (RMDs) starting the year after Sue passes away, but he is not forced to liquidate the entire account within 10 years.

Confusion With RMD Rules

This is one of the biggest areas of confusion for sibling beneficiaries.

There are two different sets of rules depending on whether the sibling qualifies for the within 10 year of age rule or not.

Situation 1: Sibling Within 10 Years of Age (Stretch Rules Apply)

If the sibling beneficiary is within 10 years of the person who passed away:

• They are using the stretch IRA rules

• They must take RMDs every year

• RMDs begin the year after death

• RMDs are calculated using the IRS Single Life Expectancy Table

• They are not required to empty the account within 10 years

This is true regardless of whether the person who died had started RMDs or not.

This is where many people get confused. Under the old stretch rules, RMDs were always required for inherited IRAs, unless the beneficiary was a spouse.

Situation 2: Sibling More Than 10 Years Younger or Older (10-Year Rule Applies)

If the sibling is more than 10 years apart in age, they do not qualify for the exception and are subject to the 10-year rule.

Example:

• Tim is age 55

• His sister Jen is age 42

• Jen inherits Tim’s IRA

Because the age difference is greater than 10 years, Jen must fully deplete the account within 10 years.

Now here’s where RMD rules depend on the age of the person who passed away:

• If the person who passed away was not RMD age (under age 73) → No annual RMDs required, but account must be emptied by year 10.

• If the person who passed away was already taking RMDs → The beneficiary must continue taking annual RMDs during the 10-year period.

Tax Strategies for Siblings Inheriting Retirement Accounts

This is where planning becomes very important, especially for siblings subject to the 10-year rule.

Strategy for Inherited Pre-Tax IRA or 401(k)

Distributions from inherited pre-tax retirement accounts are taxable income.

If you wait until year 10 and withdraw the entire account at once, that could push you into a very high tax bracket.

So in many cases, it may make sense to:

• Take distributions gradually over the 10 years

• Spread the tax liability over multiple years

• Coordinate withdrawals with lower-income years

• Take more in years where income is lower (retirement, job change, etc.)

Strategy for Inherited Roth IRA

If a sibling inherits a Roth IRA and is subject to the 10-year rule:

• The account grows tax-free

• Withdrawals are tax-free

• The strategy is often to wait until year 10 and withdraw the account at the last possible moment to maximize tax-free growth

So the strategy is often:

• Pre-tax account → Spread withdrawals out

• Roth account → Wait as long as possible

Advanced Tax Strategy: The “Tax Bracket Wash” Strategy

There is also a more advanced strategy for individuals who are still working and inheriting a pre-tax retirement account.

If someone:

• Takes a distribution from an inherited IRA (taxable)

• Then increases their pre-tax contributions to their employer retirement plan (401(k), 403(b), etc.)

They may be able to offset the taxable income from the inherited IRA distribution with the tax deduction from increasing their pre-tax contributions.

In simple terms, they are:

Taking money out with one hand and putting money back into a retirement account with the other hand, while potentially neutralizing the tax impact.

This can be a very effective strategy for high-income earners who are not already maxing out their employer retirement plans.

Summary

When inheriting a retirement account from a sibling, the most important factor is the age difference between the siblings.

There are two main categories:

If Siblings Are Within 10 Years of Age:

• Eligible Designated Beneficiary

• Can use the stretch IRA rules

• Must take annual RMDs

• Do not have to empty the account within 10 years

If Siblings Are More Than 10 Years Apart:

• Subject to the 10-year rule

• Must empty the account within 10 years

• May or may not have to take annual RMDs depending on the age of the sibling who passed away

Because inherited retirement accounts can have significant tax consequences, beneficiaries should strongly consider working with a financial advisor and tax professional to determine the best withdrawal strategy.

About Michael……...

Hi, I’m Michael Ruger. I’m the managing partner of Greenbush Financial Group and the creator of the nationally recognized Money Smart Board blog . I created the blog because there are a lot of events in life that require important financial decisions. The goal is to help our readers avoid big financial missteps, discover financial solutions that they were not aware of, and to optimize their financial future.

Frequently Asked Questions

1. Do siblings have to follow the 10-year rule when inheriting an IRA?
   Only if they are more than 10 years apart in age.
2. What happens if siblings are within 10 years of age?
   They can stretch distributions over their lifetime and take RMDs each year.
3. When do RMDs start for stretch rule inherited IRAs?
   Typically starting the year after the original owner passes away.
4. Do I have to take RMDs if I'm subject to the 10-year rule?
   It depends on whether the person who passed away had started RMDs.
5. Are inherited IRA distributions taxable?
   Yes, if it is a pre-tax IRA or 401(k).
6. Are inherited Roth IRA distributions taxable?
   No, Roth IRA distributions are typically tax-free.
7. Should I take money out each year or wait until year 10?
   It depends on your tax bracket and whether the account is pre-tax or Roth.
8. What is the stretch IRA rule?
   It allows beneficiaries to take RMDs over their lifetime instead of emptying the account in 10 years.
9. Can I reduce taxes from an inherited IRA?
   Yes, by spreading distributions over multiple years, waiting until lower income years to process distributions, or coordinating with retirement plan contributions.
10. Should I talk to a financial advisor about inherited retirement accounts?
    Yes, because the withdrawal strategy can significantly impact how much tax you pay.

The SECURE Act 10-Year Rule Explained: Higher Taxes for Kids Who Inherit IRAs

When Congress passed the SECURE Act, one of the most significant changes for families came from the new 10-year rule for inherited IRAs. The rule eliminated the ability for most non-spouse beneficiaries, especially adult children, to stretch required distributions over their lifetime. Now, they must empty the account within 10 years of inheriting it.

While this might sound simple, the tax impact can be severe. Compressed distribution windows often push heirs into higher brackets, accelerating income tax on decades of savings. Here is what the rule actually requires and how strategic planning can reduce the hit.

What the SECURE Act’s 10-Year Rule Says

Under the SECURE Act, when a child or other non-spouse inherits an IRA or 401(k), they must withdraw all funds by December 31 of the 10th year following the account owner’s death.

Before 2020, many beneficiaries could stretch required minimum distributions over their own life expectancy, sometimes 30 years or more, allowing continued tax-deferred growth. The SECURE Act ended that option for most heirs.

The result is that your kids will likely pay taxes on inherited retirement funds faster, and at potentially higher marginal rates, than they would have under the old rules.

Who the Rule Applies To

The 10-year rule applies to most non-spouse beneficiaries, but there are exceptions.

The rule applies to:

• Adult children or grandchildren
• Siblings, nieces, nephews, or other non-spouse heirs
• Trusts named as beneficiaries unless they qualify as see-through trusts

The rule does not apply to:

• Surviving spouses
• Minor children until they reach age 21, when the 10-year clock starts
• Disabled or chronically ill beneficiaries
• Beneficiaries less than 10 years younger than the account owner

The Hidden Tax Trap

For many families, the problem is not just the loss of tax deferral. It is the timing of the withdrawals. Most heirs inherit these accounts in their 40s or 50s, right in their peak earning years. Adding large inherited IRA distributions on top of salary and bonuses can easily push them into higher tax brackets.

Example:
If your child earns $120,000 per year and inherits a $1 million traditional IRA, they have just 10 years to withdraw it. Even spreading it evenly means an extra $100,000 in taxable income per year, enough to move them into a much higher bracket and increase Medicare or Net Investment Income taxes if applicable.

Our analysis at Greenbush Financial Group shows that this compression effect often results in 5 to 10 percent higher effective tax rates on inherited IRA dollars compared to pre-SECURE Act rules.

Planning Strategies to Reduce the Impact

There are several ways to mitigate the 10-year rule’s tax impact:

1. Roth conversions during your lifetime
   Converting pre-tax IRAs to Roths allows your children to inherit tax-free assets. They will still follow the 10-year withdrawal rule, but distributions will be tax-free.

2. Strategic beneficiary designations
   Leave portions of retirement assets to lower-income heirs or to charitable remainder trusts.

3. Staggered inheritances
   Use taxable accounts, life insurance, or non-retirement assets to balance out future income for your kids.

4. Pre-death withdrawals
   Taking larger distributions during your own lower-income retirement years can smooth taxes across generations.

5. Trust planning
   Review existing conduit trusts. Many written before 2020 no longer operate as intended under the 10-year rule.

At Greenbush Financial Group, we often run multi-scenario tax projections showing how different withdrawal schedules, Roth conversions, or charitable strategies affect heirs’ long-term tax burdens.

Why This Matters for Your Estate Plan

The 10-year rule changed how retirement wealth passes between generations. What used to be a slow, tax-efficient transfer can now create a rapid, high-tax inheritance event.

Updating your beneficiary designations, estate documents, and withdrawal strategy is critical if you want your children to keep more of what you have saved. Even a modest Roth conversion plan or trust revision can reduce total taxes by hundreds of thousands of dollars over time.

Rob Mangold

About Rob……...

Hi, I’m Rob Mangold. I’m the Chief Operating Officer at Greenbush Financial Group and a contributor to the Money Smart Board blog. We created the blog to provide strategies that will help our readers personally, professionally, and financially. Our blog is meant to be a resource. If there are questions that you need answered, please feel free to join in on the discussion or contact me directly.

FAQs: SECURE Act 10-Year Rule

1. Do my kids have to take money out every year?
   Maybe. Annual required minimum distributions may be required if the decedent was of RMD age at passing. The RMD amount is likely less than one tenth of the account. The beneficiaries must still empty the inherited IRA by the end of year 10, so creating a strategy to reduce the overall tax burden is recommended.
2. Does the 10-year rule apply to Roth IRAs?
   Yes, but Roth withdrawals are tax-free. Heirs still need to empty the account within 10 years.
3. How does this affect trusts as IRA beneficiaries?
   Many conduit trusts written before 2020 now force the entire balance out in year 10, losing the intended protection and control. These should be reviewed.
4. Can I avoid the 10-year rule for my kids?
   Not directly, unless your child qualifies as an eligible beneficiary such as a minor or disabled dependent. Strategic Roth conversions or life insurance can help achieve similar goals.
5. Should I change my IRA beneficiaries now?
   Possibly. If your current structure assumed lifetime stretch distributions, it is time to review it under the new law.