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A woman retired at age 64 with $380,000 in her 401(k) and spent the next nine years without employment income. During that period, she did not convert any of her retirement savings to a Roth IRA. When the time came to begin taking required withdrawals, her first RMD (Required Minimum Distribution) was ultimately taxed at a 22% rate.
The case illustrates how the years between retirement and the start of required minimum distributions can become an important window for tax planning. For this retiree, that period lasted from age 64 to 73, since current rules under SECURE 2.0 set the RMD starting age at 73 for people born between 1951 and 1959. For those born in 1960 or later, the age is currently 75.
Nine years without conversions
During the nine years after retiring, the woman had no salary or pension and had not yet begun collecting Social Security. As a result, her taxable income was extremely low.
That situation could have allowed her to take advantage of lower tax brackets by making partial conversions from a traditional retirement account to a Roth IRA. A conversion generally creates taxable income on the amount converted, but the funds can then grow inside the Roth and potentially be withdrawn tax-free if the applicable rules are met.
The problem is that unused room in lower tax brackets does not carry over from one year to the next. Every year that passed without a conversion represented an opportunity that was permanently lost.
From $380,000 to $642,000
While the retiree left her 401(k) untouched, the money continued to grow. Under the scenario analyzed, assuming an average 6% annual return, the initial $380,000 would have increased to approximately $642,000 by the time she reached age 73.
When RMDs began, tax rules required her first distribution to be calculated using the applicable divisor from the Uniform Lifetime Table, which in this case was 26.5. That resulted in an initial RMD of approximately $24,200.
The tax situation became more complicated once Social Security benefits were added. The retiree began collecting Social Security at age 70 and, under the scenario presented, up to 85% of those benefits was taxable. When those benefits were combined with the RMD, part of the distribution moved beyond the 12% tax bracket and into the 22% bracket.
What she could have done differently
One common strategy for someone in a similar situation is to make partial Roth conversions during years when taxable income is lower. The goal is to convert enough each year to take advantage of a particular tax bracket without creating an unnecessarily large tax bill.
In this case, making conversions during those nine years could have reduced the amount remaining in the traditional 401(k). That, in turn, could have lowered the account balance used to calculate future RMDs and potentially reduced the amount of taxable income during retirement.
The strategy also requires considering where the money to pay the conversion taxes comes from. When possible, paying those taxes with savings outside the retirement account allows the full converted amount to remain in the Roth and gives it more time to grow.
The timing of Social Security can also affect the outcome. Once benefits begin, certain Roth conversions can result in a higher tax bill and may also increase the portion of Social Security benefits subject to taxation.
The importance of the transition years
This woman’s case does not mean that everyone who retires with $380,000 should make Roth conversions or that an RMD will necessarily be taxed at 22%. Each person’s tax situation depends on factors such as filing status, other sources of income, when Social Security begins, retirement account balances and the tax rules in effect at the time.
What the example does show is the importance of the so-called “gap years” — the years between a person’s last paycheck and the start of RMDs. During this period, taxable income may be significantly lower, giving retirees more room to consider different tax-planning strategies.
In the scenario analyzed, the nine years between ages 64 and 73 represented a window that did not reopen. Meanwhile, the $380,000 continued growing to roughly $642,000, also increasing the size of the future required distributions.
For people approaching retirement, the case serves as a reminder that leaving traditional retirement savings untouched for years may seem like the simplest option, but it can also have tax consequences once required minimum distributions begin.