Roth Conversions: When They Make Sense in Retirement

Colton Richards, CFP®

August 12, 2024

Roth Conversions: When They Make Sense in Retirement

Colton Richards, CFP®

A Roth conversion is relatively simple to explain.

You move money from a pre-tax retirement account into a Roth account and pay income taxes on the converted amount today.

But that's not really the important part.

The important question is:

Why would you voluntarily pay taxes today on money you don't need yet?

For the right retiree, the answer may be that paying taxes intentionally today creates greater flexibility — and potentially a lower lifetime tax burden — later.

The challenge is timing.

Some of the best Roth conversion opportunities occur during a relatively short window around retirement. Once that window closes, you may not get it back.

What Is a Roth Conversion?

A Roth conversion moves assets from a pre-tax retirement account, such as a Traditional IRA, into a Roth IRA.

Generally, the taxable portion converted is included as ordinary income in the year of the conversion. In exchange, assets inside the Roth IRA can continue growing, and qualified Roth IRA distributions can ultimately be tax-free. Roth IRA owners also aren't subject to lifetime Required Minimum Distributions under current rules.

The goal isn't simply:

Pay taxes now so you don't pay them later.

The better question is:

When is the most advantageous time during your lifetime to recognize the taxable income?

That's where Roth conversion planning becomes much more interesting.

The Retirement Tax Window

One of the most common Roth conversion opportunities occurs shortly after someone retires.

Imagine you've spent your career earning $250,000 a year.

Then you retire at 63.

Suddenly:

your salary disappears
Social Security may not have started
Required Minimum Distributions haven't begun
your taxable income may fall substantially

That can create a temporary retirement tax window.

Instead of allowing that lower-income year to pass unused, you may intentionally move some pre-tax retirement assets into a Roth IRA.

Similar opportunities can occur when:

one spouse retires before the other
someone takes a sabbatical
a business owner has an unusually low-income year
someone transitions between careers
retirement begins before Social Security

We discuss these opportunities more broadly in Tax Planning for Retirees in Dallas.

Why Waiting Can Be Expensive

One of the biggest mistakes we see isn't making a bad Roth conversion.

It's never evaluating one at all.

Someone retires with a large 401(k), rolls it into an IRA and begins taking distributions as needed.

Maybe they withhold 20% for taxes.

Everything feels normal.

But every year that passes may be another year in which a potentially valuable lower-income tax bracket went unused.

Meanwhile, the remaining IRA may continue compounding.

Eventually, Required Minimum Distributions begin and the decision changes.

Traditional IRA owners generally must begin RMDs at the applicable age under current law, and those distributions can create taxable income whether the retiree needs the money or not.

At that point, you're operating with fewer choices.

That's why our Required Minimum Distribution planning philosophy starts years before the first RMD.

By the time the RMD arrives, much of the best planning window may already be behind you.

A Real Roth Conversion Example

Consider a real planning situation we've encountered, with identifying details omitted.

Nearly all of the client's retirement savings had accumulated inside a pre-tax 401(k).

Nobody had ever meaningfully projected the future tax consequences.

By the time we evaluated the plan, the pre-tax retirement balance had grown to approximately $1.5 million.

That's a successful outcome from a savings perspective.

But it also represented a significant future tax liability.

After reviewing the client's retirement projections, we developed a strategy to convert approximately $464,000 to Roth over three years rather than converting everything at once.

According to the planning projections, the strategy was estimated to:

reduce lifetime taxes by approximately $146,000
result in approximately $343,000 more in projected retirement assets
maintain the client's ability to retire at the planned age

Those results aren't universal and depend heavily on assumptions about future returns, tax rates, spending and longevity. They aren't a promise of what another household would experience.

But the example illustrates something important:

The value wasn't simply "doing a Roth conversion."

It came from identifying a limited planning window and determining how much to convert and when.

How Much Should You Convert to Roth?

This is where Roth conversion planning becomes more complicated.

The answer generally isn't:

Convert as much as possible.

A conversion creates taxable income. Converting too much can potentially push income into higher tax brackets or create other unintended consequences.

For 2026, for example, federal marginal income tax rates continue to range from 10% through 37%, with the 24% bracket followed by a significant jump to 32%.

At Apeiron, we generally don't want to push Roth conversions beyond the 24% federal bracket based on our current planning philosophy.

But that doesn't mean everyone should automatically fill the 24% bracket.

The appropriate amount depends on the complete tax picture.

We may evaluate:

current taxable income
current marginal tax bracket
projected future tax brackets
IRA and 401(k) balances
projected RMDs
Social Security timing
Medicare considerations
investment growth assumptions
spending needs
available taxable assets
estate and beneficiary goals

Sometimes the best answer is a large conversion.

Sometimes it's a smaller conversion.

Sometimes it's no conversion at all.

The strategy matters more than the transaction.

"Why Convert at 24% If I Might Still Be in the 24% Bracket Later?"

This is a great question.

A Roth conversion doesn't necessarily require today's marginal tax rate to be dramatically lower than the future rate to potentially create value.

Moving money into a Roth earlier also changes where future compounding occurs.

Instead of allowing all future growth to occur inside a pre-tax account that may eventually generate taxable distributions, some of that growth can occur inside a Roth account where qualified distributions can be tax-free.

That can create additional flexibility later in retirement.

It may also reduce the size of future pre-tax balances and, therefore, future RMD pressure.

The calculation still depends on the household's individual circumstances. Paying a tax today isn't automatically better simply because the account says "Roth."

But tax rate isn't the only variable worth evaluating.

The $1 Million Pre-Tax Retirement Account Question

There isn't a magic IRA or 401(k) balance where Roth conversions suddenly become necessary.

But we think there is a useful planning checkpoint:

If you're approaching retirement with $1 million or more in pre-tax retirement accounts, Roth conversions should at least be evaluated.

That doesn't mean you should convert.

It means the potential future tax liability has become large enough that ignoring it could be consequential.

A $1 million IRA isn't really just $1 million of spendable money.

Some portion effectively represents a future tax obligation.

And if the account continues growing before RMDs begin, that obligation can grow alongside it.

Why a Brokerage Account Can Make Roth Conversions Easier

This is another reason we talk so frequently about taxable brokerage accounts.

Suppose virtually all of your money is inside an IRA.

You decide to complete a Roth conversion.

Now you owe taxes.

Where does the money to pay those taxes come from?

Having taxable assets outside the retirement account can create significantly more flexibility.

It can potentially allow you to pay the conversion tax without needing to use additional retirement dollars to cover the bill.

It can also provide spending money during the lower-income retirement years in which you're intentionally creating taxable income through conversions.

This is one reason we call the taxable brokerage account the missing middle for many retirees.

We explain the strategy in Why High Earners Need Brokerage Accounts Beyond Their 401(k).

Roth Conversions and Medicare IRMAA

Taxes aren't the only consideration.

A Roth conversion increases income in the year of conversion, and higher income can also affect income-related Medicare premiums.

That's why we don't evaluate Roth conversions solely by looking at federal income tax brackets.

Sometimes people become overly focused on avoiding an IRMAA threshold.

That can be shortsighted too.

If crossing a Medicare threshold creates a few thousand dollars of additional cost but a larger Roth conversion is projected to save substantially more in lifetime taxes, paying the additional Medicare cost may still be worthwhile.

The objective isn't:

Avoid IRMAA at all costs.

It's:

Understand all the costs and benefits before making the decision.

Roth Conversions and RMDs

Roth conversion planning and RMD planning are closely connected.

Converting some pre-tax assets before RMD age can reduce the balance that will eventually be subject to mandatory distributions.

That can potentially give retirees more control over taxable income later.

For people who eventually have RMDs they don't need for spending, there are still planning strategies available, including reinvesting excess distributions and, for charitably inclined retirees, using Qualified Charitable Distributions.

We cover those situations in What Should You Do With RMDs You Don't Need? and our broader Charitable Planning resources.

But we'd rather evaluate the tax problem before someone becomes cornered by mandatory distributions.

When Roth Conversions May Not Make Sense

Roth conversions aren't inherently good.

There are plenty of situations where converting may not be attractive.

For example:

you're currently in an unusually high tax bracket
your future taxable income is expected to be substantially lower
you don't have sufficient liquidity to comfortably pay the tax
the conversion creates undesirable secondary tax consequences
charitable or estate strategies make retaining pre-tax assets more attractive
you need the IRA assets for near-term spending

And Roth conversions generally can't simply be undone later: under current federal rules, conversions made after 2017 cannot be recharacterized back into a Traditional IRA.

That's another reason the analysis should happen before executing the transaction.

Roth Conversion Planning Is Really Lifetime Tax Planning

This is the part we want retirees to understand most.

The goal isn't paying the lowest possible tax bill this year.

The goal is managing taxes over your lifetime.

That may mean intentionally paying more taxes during certain years.

It can feel counterintuitive.

But if paying taxes at an intentional rate today reduces a larger future tax burden, creates tax diversification, reduces future RMDs and gives you greater control over retirement income, the current tax bill may be worth paying.

That's why Roth conversions shouldn't be evaluated in isolation.

They should be coordinated with your broader retirement income plan, Social Security, investments, RMDs, charitable goals and estate plan.

When Should You Start Looking at Roth Conversions?

Ideally, before you retire.

If you're five to ten years from retirement, you can begin projecting:

what your pre-tax accounts may become
when income could decline
when Social Security might begin
when RMDs will eventually start
where potential conversion windows could exist

You don't necessarily need to convert today.

You need to know when the opportunity may arrive.

And if retirement has already created a lower-income year, don't assume you have to wait until year-end or until RMDs become a problem to start evaluating it.

These opportunities can be use-it-or-lose-it.

The Bottom Line

A Roth conversion isn't valuable simply because Roth accounts are tax-free.

It's valuable when the conversion helps improve your overall retirement tax strategy.

For someone approaching retirement with substantial pre-tax savings, one of the most important questions may be:

Am I paying taxes on these dollars at the right time?

You spent decades making smart decisions about how much to save.

As retirement approaches, it becomes equally important to decide how those savings should eventually be taxed.

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