Accumulating a large balance in a traditional retirement account is a great thing in theory — until the reality of required minimum distributions (RMDs) sets in. Suddenly, the freedom that comes with having a gigantic nest egg becomes a potential tax liability that could come with hidden consequences, like Medicare IRMAAs that drive your costs up substantially.
Let’s take the example of a 63-year-old couple living in New York State (in a suburb of NYC) who are sitting on $4.2 million. They want to convert a good chunk of that sum to a Roth IRA. From there, they’ll enjoy tax-deferred growth on that money, tax-free withdrawals, and importantly, no RMDs.
But New York is one of the least tax-friendly states to do a Roth conversion. With state tax rates ranging from 4% to 10.9%, converting even half of a $4.2 million retirement account balance could cost this couple a substantial amount.
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The ‘Florida Flip’ — annual conversions in a no-tax state
The potential solution? The “Florida Flip.” Move to Florida for about 12 years to avoid state taxes on the conversion.
For the couple in our example, converting a 4.2 million nest egg over 12 years could yield significant savings when done strategically. Over 12 years, they would convert $350,000 annually (though they may qualify for a New York tax break, more on that below). That extra taxable income could result in an annual state tax bill in the tens of thousands in New York.
The Florida plan could shave off about $250,000 in state taxes over 12 years, depending on the couple’s tax tier. So it’s certainly a good idea in theory. But proper execution is everything.
You need to truly make a clean break from your home state
There’s a reason Florida tends to attract retirees beyond just the weather. It’s one of the few U.S. states with no income tax. That makes it a good place to do a Roth conversion. But you need to do it carefully, since New York is likely to pursue conversion taxes it thinks it’s owed.
“Aggressive state tax pursuit is concentrated in high-tax states, because the flow of lost revenue each year is so massive,” explains John Moran, CFP at Domain Money. “New York runs one of the most active residency auditing programs in the country, both because of the high taxes departing residents take with them and the sheer quantity of retirees leaving in pursuit of lower tax rates.”
For this reason, Moran says, if you’re going to pursue this strategy, you must make a truly clean break.
“The risk for this couple is New York questioning their departure, not Florida questioning their arrival,” he says.
Leaving New York isn’t enough
You might assume that all you need to do to initiate a “clean” Roth conversion in Florida is pack your bags. But Moran says there’s a lot more to it.
“Simply moving to another state and updating their license does not automatically close the door on New York coming for their [tax money],” Moran says. “If they keep a home in New York and spend enough days in the state, New York can treat them as statutory residents and tax the conversion anyway, so both the number of days spent in the state and the use of any retained property matter.”
Steven McGowan, Managing Director and Wealth Advisor at Rothschild Wealth Partners, further explains, “The standard defense is a clean factual record you are responsible for tracking — fewer than 184 days in New York [per year], updated driver’s license, voter registration, bank and brokerage addresses, and a detailed day-by-day location log backed by receipts and travel records. Seriously.”
Moran says the key is to show that you’ve really cut ties with New York. In addition to spending the majority of your time in Florida, you need to show that you’re actively establishing a life there. That means finding doctors based in Florida, joining a gym, and doing other such things that send the message that this is truly your new home.
Moran also says that if New York questions your residency, “The burden of proof in a residency audit falls on the taxpayer, which makes recordkeeping vital.” So make sure to document how much time you’re spending in New York versus Florida, at least for the first year or two following your move.
Another important point McGowan raises is that you should establish residency in Florida before moving any money into a Roth IRA.
“Relocate first, document everything, establish Florida domicile clearly, check your models again, and then and only then convert,” he says. McGowan also suggests having a tax attorney and a financial planner review everything together before a single dollar moves.
Make sure a Roth conversion actually fits into your plans
Relocating to Florida could be a good way to save money on Roth conversion taxes. But McGowan says that before you uproot your life, you should run the numbers carefully.
“A conversion this size creates a significant ordinary income spike that can affect Medicare premiums, Social Security taxation, and other income-based phaseouts. That math needs to be modeled carefully,” he cautions.
McGowan says it’s also important to ensure you’re pursuing a Roth conversion for the right reasons.
“Are you trying to create more tax flexibility in retirement, reduce future RMDs, simplify estate planning, or pass wealth more efficiently to heirs? Because the federal tax cost is still very real, no matter where you live,” he says.
Since you’re dealing with a very large nest egg, converting just $200,000 to $300,000 a year could place you in a higher tax bracket.
Granted, if you let a $4.2 million nest egg grow another 12 years, your RMDs plus other retirement income could place you in a high enough bracket that it’s worth converting now. But it pays to work with a tax professional or financial adviser to run the numbers.
And also, don’t be surprised if your 12-year conversion leaves you paying more for Medicare. Depending on your total income, IRMAAs may be unavoidable for at least some of those years. (Note that Medicare uses a two-year lookback period to calculate IRMAAs.)
Finally, to make your Roth conversion as efficient as possible, it’s best to plan to pay the taxes from a taxable brokerage account or savings/checking account. That way, you can leave the entire converted balance inside your Roth IRA to grow tax-free.
Understand the costs of moving to Florida
Giving yourself 12 years in Florida to convert some or all of a $4.2 million portfolio is a great strategy for minimizing the federal tax burden, since you’ll conceivably only be moving a portion of your total balance over each year. But one final thing you’ll need to do is make sure you understand the costs associated with moving to Florida.
With a median property tax bill of $6,542, New York is one of the most expensive states for homeowners. Our imaginary couple living just outside New York City would no doubt pay much higher state and local taxes. Florida, on the other hand, is one of the most expensive states for homeowners’ insurance. Plus, in Florida, you could face hefty HOA fees that add to your monthly costs.
Granted, if you own a home in or near New York City and you’re planning to sell it ahead of your Florida move, you may be able to pocket enough proceeds to cover the cost of a new place with money left over to pay for insurance, HOA fees, and other expenses that come with living in Florida. But do the math before making that move. You don’t want to end up in a situation where what you save in taxes on your conversion, you lose to other expenses.
Another thing to think about is the 12-year Florida plan. If you’re buying and selling various homes within a relatively short stretch of time, you’re looking at real estate agent fees, moving costs, and other expenses. Some retirees reduce their final home purchase costs using the “half-back” approach: they move to Florida for several years, then settle halfway back to New York or New England to be closer to family while enjoying lower real estate prices.
Also note that if you’re 59½ or older, you may qualify for New York State’s $20,000 per-person retirement income exclusion. As a couple, you could potentially exempt $40,000 of income per year. In our scenario, the 63-year-old couple would pay state taxes on $310,000 of their annual Roth conversion rather than $350,000.
Granted, Florida’s lack of an income tax may result in significantly greater net tax savings overall. But you should know what benefits you’re giving up by leaving New York.
And some of those benefits may not be financial. If your family and social network are based in New York, there’s an emotional cost to giving those up. So really take a look at the big picture before gearing up to pack your bags.
All told, you can potentially save money on a large conversion by moving to a no-income-tax state if you run the numbers and they work in your favor. But that’s a big “if.” And if you’re going to make the move, make certain it’s a truly clean break so your home state doesn’t try to come after you for extra money
