Roth Conversions Before and During Retirement
Executive Summary
Every dollar in a traditional 401(k) or IRA will eventually be taxed — the only question is when and at what rate. A Roth conversion lets you pay that tax now, on your terms, in exchange for tax-free growth and withdrawals for the rest of your life.
The central question is simple: will your tax rate be higher or lower in the future than it is today? The answer drives whether — and when — a conversion makes sense for you.
High-income earners still working are often at or near their peak tax rate, making large conversions less attractive — though “filling up” lower brackets and the estate planning benefit of tax-free inheritance can still make partial conversions worthwhile.
For retirees not yet collecting Social Security or taking required minimum distributions (RMDs), the window of temporarily low income is often the single best opportunity to convert — potentially at rates as low as 12% or even zero.
Converting now reduces your future RMD balance — giving you more control over your taxable income in later retirement, when Social Security, RMDs, and Medicare surcharges can interact to push you into a higher bracket.
Roth conversions require planning and modeling — not guesswork. Toimal amount to convert, and the right number of years over which to do it, depends on your specific income, tax situation, and retirement timeline. The time to start that conversation is before retirement, not after.
Introduction
Traditional 401(k)s and IRAs are a great tool for saving money during your high-earning (and high-tax) years. With the outstanding performance of the stock market over the past ten years (the S&P 500 is up nearly 300% over that period), many folks have hefty balances. The total balance can be a little misleading, however. Every dollar in the accounts will eventually be taxed, reducing the amount available to you in retirement. The only question is when and at what rate. Because of this, Roth conversions can be a valuable tax-planning tool to minimize the total tax you (or your heirs) will eventually pay on your 401(k) and IRA account balances.
Roth Conversion Basics: A Refresher
When you do a Roth conversion, you move money from your traditional 401(k) or IRA account to a separate Roth account. The amount you move is counted as income and taxed in the year that you make the move. Essentially, you are electing to pay taxes now in return for a significant future benefit: tax-free growth of the Roth balance over the rest of your life.
The decision to do a Roth conversion turns on a key question: are you likely to be in a higher or lower tax bracket than you are today? If you are still working at peak earnings, your tax rate today may be higher than it will be in retirement, which can make large conversions less attractive right now. On the other hand, if you have recently retired and your income has dropped, you may be in a lower bracket today than you will be once Social Security and required minimum distributions kick in — making conversions potentially very valuable.
Note: You should generally plan to keep the money you convert in the Roth account for at least five years and until after you reach age 59½. Otherwise, you may owe taxes and penalties. The rules on withdrawals are unnecessarily complex, and a professional can be useful in navigating them.
High-Income Earners Approaching Retirement
If you fall in this category, you may be at your highest lifetime annual income. As a result, your marginal tax bracket – the rate at which you pay taxes on your last dollar of income (such as Roth conversions) -- may be higher than it will be in retirement, particularly the early years before Social Security and required minimum distributions start.
If this is the case, Roth conversions can usually wait. There are other hidden effects of raising your taxable income during an already high-tax year, including:
the 3.8% surtax on investment income (on your income above $250,000, for married filing jointly)
triggering a temporary increase in your Medicare premiums, if your income is high enough within two years of a year you or your spouse are enrolled in Medicare
The question is a closer one if you are in one of the middle tax brackets (like 22% or 24%). You can elect to “fill up” those brackets with Roth conversions if you are likely to be in these brackets or higher during most of your retirement (a not uncommon scenario). There is also an estate planning dimension worth noting: Roth accounts pass to your heirs income-tax-free, which can be a meaningful benefit for those with large pre-tax balances they may not fully spend in their lifetime.
Retirees Not Yet Claiming Social Security or Receiving Required Minimum Distributions
In the years following your retirement, your taxable income may be lower than it has been in a long time. Your income will increase once you claim Social Security (for example, at age 67), with a further increase once you are required to start withdrawing money from your pre-tax retirement accounts at age 73 or 75, depending when you were born. These are known as “required minimum distributions” or “RMDs”.
The window before Social Security and RMDs start can be a great time for Roth conversions. Your marginal tax rate may be very low, even potentially zero. Any amounts you convert now will be taxed at that rate, instead of a potentially higher future rate. As a reminder, any future growth in the Roth account will be tax-free as long as you follow withdrawal rules.
By reducing the balance in your pre-tax accounts, you are managing the amount of your future RMDs, which may be taxed at higher rates due to your higher income in the future. Once RMDs start, you have less control, as they are calculated based on your pre-tax account balance each year. The more you have already moved into a Roth, the less will be subject to the mandatory withdrawal formula.
Roth conversions can also be a powerful tool to manage a surviving spouse’s tax liability. Single filers are taxed at higher rates than couples filing jointly. Following a spouse’s death, income may go down (due to the loss of a Social Security benefit, for example), but the survivor’s taxable income can still be substantial — particularly when a large IRA is inherited — and it will now be taxed in the compressed single-filer brackets. Roth conversion planning while both spouses are alive can help manage this issue.
Retirees still must watch for tax gotchas when deciding upon a Roth conversion amount. Large one-time conversions can trigger future Medicare surcharges, for example. Often, a calibrated conversion strategy over multiple years is optimal.
Conclusion
Roth conversions are a precision tool that can deliver significant lifetime tax savings. Like any tool, they are only useful in the right circumstances. To implement a successful Roth conversion strategy, you must have a good understanding of your taxable income, marginal tax bracket and expected future tax rates. You also need to have a view on how your income will change in future years, even if it is a rough estimate. Timing is important, and you often have an optimal window of time during which to complete conversions, after which they are not as powerful. For this reason, early planning, starting before retirement, is important. If you would like to explore whether a Roth conversion strategy makes sense for your situation, please reach out — we would be happy to model the numbers with you.