Skeels Cygan: Here are some strategies for Roth conversions

If you are considering doing a Roth conversion, this article is for you.

This is the third column in a three-part series. The first one, “10 reasons not to do a Roth conversion,” ran in early June and the second came out in early July — “The many benefits of a Roth conversion.”

Deciding whether a Roth conversion is prudent has many factors to consider, but in my view, there are two primary factors. First, do you expect to save money on taxes long-term if you pay taxes now to do a Roth conversion? And second, do you have a desire to leave a retirement account — a Roth IRA — to your children or grandchildren tax-free after you die?

A refresher

As I covered in earlier articles, moving money from a traditional IRA (which is tax-deferred) to a Roth IRA (which is tax-free going forward) requires that you pay income taxes on the amount you convert in the year you convert. Moving your money to a Roth so the future growth and compounding in the account is tax-free provides powerful benefits, as well as allowing you to leave the Roth IRA to children or grandchildren tax-free.

In spite of the benefits of a Roth conversion, there are several scenarios in which converting to a Roth may not be wise. If your traditional IRA is not large, and you plan to use the RMDs (required minimum distributions) for living expenses during retirement, then a Roth conversion is unnecessary. Likewise, if you expect your tax rate during retirement to be less than it is now, or if you plan to leave your traditional IRA to charity, then a Roth conversion may not be wise. And finally, it is best to pay the taxes due on a Roth conversion from an after-tax account rather than from your traditional IRA. If you do not have money available to pay the taxes from an after-tax (or bank) account, a Roth conversion is less favorable.

Tax issues

Some financial planners believe that your decision about whether to do a Roth conversion should be based only on whether you expect your tax rate in retirement to be equal to or less than it is now. This is one viewpoint, but it ignores other important factors.

A major factor is to determine whether the RMDs during retirement — required by traditional IRAs — will cause you tax problems. Many investors have realized their large traditional IRAs will keep them in a high tax bracket for their entire lives. This is called a “tax torpedo.”

To analyze this issue, you need to project the value of your traditional IRA at the time you will be required to start RMDs (currently age 73 but age 75 if you were born in 1960 or later). If you are still contributing to your traditional IRA, or traditional 401(k), you may want to assume 7% to 8% growth per year for compounding and new contributions. For this example, let’s assume you are age 45 and you have $400,000 in a traditional IRA or traditional 401(k). If we assume a growth rate of 8% per year, the account would grow to $4.025 million by age 75.

Next, estimate what your annual RMD will be (it starts at roughly 4% at age 75 and increases each year). So in our example, the RMD would be approximately $161,000 at age 75. You would then add Social Security income, and any pension, annuity or investment income you or your spouse expect to have. These estimates can help you determine whether you want to do a Roth conversion to avoid future RMDs.

If you have decided you want to do a Roth conversion, it is essential that you analyze your situation to decide when you want to do the conversion and how much you want to convert.

Although we are discussing converting a traditional IRA to a Roth IRA, the same concept pertains to a traditional 401(k) or 403(b). Most employers allow what they call “in-plan conversions” so you can convert to the Roth option within your employer plan.

Potential strategies

Partial conversions: A common strategy for people in their 40s or 50s is to convert a portion of the traditional IRA each year for several years. If someone is 50 and has a $400,000 traditional IRA, they may decide to convert $40,000 a year for 10 years, or $50,000 a year for eight years, or $100,000 a year for four years. There are no requirements for the amount you convert each year.

Low-income year: Another strategy is to look for a year when your income may be low, and convert in that year. This could occur if someone is between jobs or is starting a business.

Retirees: What about for people who are already retired? You can convert a traditional IRA to a Roth IRA at any age. If you are already taking RMDs, you must take your RMD first each year, but you can then do a Roth conversion later in that same year. Rather than take your RMD as a distribution, you may want to consider gifting your RMD to charity using a “qualified charitable distribution,” but that topic is for another article.

Many pre-RMD age retirees do Roth conversions to avoid RMDs completely — Roth IRAs do not have RMDs — or to minimize the RMDs.

Tax brackets: Some tax preparers and financial advisors recommend doing Roth conversions that take a taxpayer to the top of their current marginal tax bracket. Using this strategy, someone in a low 12% marginal bracket would do a Roth conversion to take them to the top of the bracket ($96,950 of taxable income in 2025 for married, filing jointly). Several recent articles have suggested going to the top of the 24% marginal bracket, which is almost $400,000 ($394,600) for married couples, filing jointly.

Other factors

IRMAA: Income Related Monthly Adjustment, or IRMAA, is a surcharge on Medicare premiums for high-income earners. It begins at age 65 but is based on a person’s income starting at age 63. Roth conversions cause your income to increase, which can trigger higher IRMAA charges. If possible, finish converting to a Roth by age 62.

Social Security income: Another factor is Social Security income. If a person is retiring soon, they may decide to convert to a Roth IRA after they retire — so their income will be lower — but before they begin receiving Social Security benefits.

Minimizing taxes: An important goal is to minimize taxes, especially because a Roth conversion will increase your income and lead to paying higher taxes. Strategies such as generous gifts to charities, bunching medical and dental expenses and utilizing tax-loss harvesting in taxable accounts can all help.

Legacy goals: Let’s assume someone has accrued a very large traditional IRA of $1 million, and they believe their income taxes would be too high to convert it fully. Perhaps their earned income from their current employer is very high, so they are in a high tax bracket. Yet they have children or grandchildren, and they are motivated to leave a Roth IRA to them tax-free. Their strategy may be to convert $25,000 or $50,000 a year, with the goal of eventually having a $100,000 Roth IRA earmarked for each of their children or grandchildren. Converting to a Roth IRA does not require “all or nothing.”

Phasing out of deductions: New factors that impact Roth conversions arose with the “Big Beautiful Bill” passed on July 4. One is the tax deduction for SALT (state and local taxes). This allows people who itemize to deduct up to $40,000 for SALT rather than the prior limit of $10,000. However, the SALT deduction starts declining at $500,000 of modified adjusted gross income and phases out completely by $600,000. If a large Roth conversion increases your income above $500,000, you may lose this tax deduction.

Another factor is the “temporary $6,000 bonus” deduction for individuals age 65 and over. For married couples, it phases out between $150,000 and $250,000 of modified adjusted gross income. Roth conversions can also trigger the 3.8% surtax for net investment income and impact other deductions.

Five-year rule: Roth IRAs have rules for taking distributions without penalties or taxes. There are exceptions, but in general, you want to have your Roth IRA to have been established at least five years earlier, and once that is met, you want to wait until after age 59-and-a-half to take withdrawals. If you are considering doing Roth conversions in the future, I encourage you to open a Roth IRA now — with a Roth contribution if income limits allow it or with a small Roth conversion — to start the 5-year clock.

Current tax rates: Compared with historical levels, current tax brackets in the U.S. are considered to be low. The bill signed by President Donald Trump on July 4 extended the current tax brackets — which were set to expire on Dec. 31, 2025 — indefinitely. We do not know how tax laws may change in the future, but the $36 trillion U.S. national debt may lead to higher tax rates in the future.

Analysis: You may notice I have not provided resources for “running the numbers” to estimate future tax savings if you convert to a Roth IRA. When I owned my financial planning firm, I purchased sophisticated retirement planning software that allowed me to isolate the Roth conversion issue for clients and estimate the long-term tax savings. Unfortunately, this software is not available to individual investors.

I have reviewed many Roth conversion calculators — some are on brokerage firm websites — and I was not satisfied with any of them. However, if you have a financial adviser, they should be able to help you with this. Your tax preparer can prepare projections for what your taxes will be if you do a Roth conversion in 2025, but they will likely not be able to project the long-term tax savings. TurboTax can also provide estimates for how your taxes will increase this year based on the size of the Roth conversion you are contemplating.

Case in point

In the spirit of full disclosure, my husband and I are doing large Roth conversions each year. We both saved throughout our careers and did not have access to Roth IRAs in the early years. We are doing the Roth conversions over eight years. We have completed five years, and have three more remaining. Although the Roth conversions increase our marginal tax bracket — and trigger IRMAA charges — we have been able to keep our effective/average tax rate below 20%.

The bottom line

Converting to a Roth IRA eliminates RMDs during retirement, may save you a significant amount of taxes over the long term and will allow you to leave your Roth IRA tax-free to children and grandchildren. The downside is paying income taxes now on the conversion. You will need to weigh the pros and cons and decide if a Roth conversion is right for you.