Roth Conversions: Part 1

When Paying Tax Today Can Make Sense

Voluntarily paying more tax than you have to this year probably doesn’t sound like much of a financial planning strategy. But occasionally, that’s exactly what good tax planning calls for.

A Roth conversion generally involves moving retirement dollars from a traditional or pre-tax retirement account into a Roth account. The previously untaxed portion of the conversion is generally included in taxable income that year, while qualified Roth withdrawals can be tax-free in the future after applicable age and holding-period requirements are met.

The tradeoff is pretty simple: Pay tax today in exchange for potentially avoiding more tax later.

The harder question is whether that trade actually improves your financial plan. Rather than asking, “Should I do a Roth conversion?” I think the more useful question is:

“Do I have an opportunity to pay tax on this money at a lower rate today than I would otherwise pay in the future?”

For several years, Roth conversions were often discussed around tax rates that were scheduled to increase after 2025. That scheduled increase ultimately did not happen; the current individual rate structure was made permanent instead.

I think that’s a useful reminder that the better planning question was never really about predicting Congress. It’s about where your own tax rate may be headed over the course of retirement.

1. You have a temporary low-income window

One of the most common Roth conversion opportunities occurs when taxable income temporarily falls. Retirement often creates a particularly useful window.

Picture someone who retires in their early 60s. Their paycheck stops, but Social Security hasn’t started and Required Minimum Distributions may still be years away. Their taxable income could be considerably lower than it was while working and lower than it may be later in retirement.

Rather than leaving some of that lower-bracket capacity unused, it can make sense to intentionally recognize additional income by converting part of a traditional IRA to a Roth IRA.

This isn’t limited to retirement. A career change, sabbatical, partial year of work, slow year in a business, unusually large deduction, or other temporary reduction in income can create the same opportunity.

The common thread is a temporary tax-planning window. If income that would otherwise be taxed at a higher rate later can be recognized at a lower rate today, a Roth conversion deserves a closer look.

2. You have a large amount of money in tax-deferred retirement accounts

Traditional IRAs and pre-tax 401(k)s are tax-deferred, not tax-free. Pre-tax contributions and earnings generally become taxable when withdrawn, and once Required Minimum Distributions begin, you have less control over when that income appears on your tax return.

Under current law, RMDs generally begin at age 73 for those born from 1951 through 1959 and at age 75 for those born in 1960 or later.

That can matter for someone entering retirement with a substantial tax-deferred balance. You might spend the first several retirement years in a modest tax bracket, only to see taxable income rise as Social Security, pension income, and RMDs begin stacking on top of one another.

Partial Roth conversions during lower-income years may help reduce future RMDs and create more tax flexibility later. This usually isn’t an all-or-nothing decision.

The better question is often how much to convert this year, and whether it makes sense to continue over several years.

3. You want more control over taxable income in retirement

One often-overlooked benefit of Roth assets is flexibility.

If nearly all of your retirement savings are in traditional IRAs and pre-tax 401(k)s, most of the money you eventually spend from those accounts will affect taxable income. Having meaningful balances across taxable, tax-deferred, and Roth accounts gives you more choices about where each year’s spending comes from.

Because qualified Roth withdrawals generally don’t increase taxable income, Roth assets can help when managing tax brackets, capital gains, Medicare premiums, large one-time expenses, charitable giving, and future RMDs.

This is one reason I don’t like evaluating a Roth conversion in isolation. A conversion that looks attractive based only on this year’s federal tax bracket can look very different once the rest of the financial plan is on the table.

But when the pieces do line up, having multiple tax buckets can provide meaningful flexibility later in retirement.

4. Your beneficiaries may eventually face higher tax rates than you do

Roth conversion planning can also extend beyond your own lifetime.

For many families, a large traditional IRA eventually becomes an inherited IRA for adult children. For many non-spouse beneficiaries, inherited retirement accounts generally must be fully distributed within 10 years, which can compress taxable distributions into years when the beneficiary is still working and earning a high income.

If those children inherit during their peak earning years, taxable distributions may land on top of salaries, business income, and other taxable income.

That raises a useful question:

Who is likely to pay the tax at the lower rate?

If retired parents are in a relatively moderate tax bracket while their children are high earners, paying some of that tax through Roth conversions during the parents’ lifetime can sometimes produce a better family-level result.

That doesn’t mean everyone should convert for the benefit of their heirs, only that the eventual recipient’s tax rate has a place in the analysis too.

5. A market decline improves an opportunity that already exists

Market declines aren’t enjoyable, but they can create tax-planning opportunities.

If an investment you plan to hold long term has fallen substantially inside a traditional IRA, that lower value gives you two ways to benefit. Converting the same number of shares you had planned to convert before the decline produces less taxable income. Or, if you convert the same dollar amount you had planned to, you end up moving more shares into the Roth without paying any more in tax.

While I wouldn’t use this as a reason to try to time the market (a decline doesn’t turn a bad Roth conversion into a good one), if the conversion already makes sense, it can make the timing more attractive.

The Bigger Picture

One of the easiest traps in tax planning is focusing entirely on this year’s tax bill. Nobody wants to pay more tax than necessary, but good retirement tax planning isn’t always about paying the least tax today.

Sometimes it means deliberately recognizing income during a lower-tax year to reduce taxes or create more flexibility for the future.

The important question to ask is: “What am I accomplishing by paying this tax now?”

If you’re using an unusually low tax rate, reducing future forced income, building more flexibility, or improving the tax treatment of what you eventually leave behind, a Roth conversion may be worth serious consideration.

If you can’t answer that question, that’s useful information too.

A Roth conversion isn’t inherently good or bad. It’s a tax-planning tool, and the value comes from using it at the right time and for the right reason.

In Part 2 of this article, I will look at the other side of the decision: when a Roth conversion may cost more than it saves, including future tax rates, Medicare premiums, state taxes, liquidity needs, and other hidden costs.

This material is provided for general informational and educational purposes only and is not intended as individualized investment, tax, or legal advice. Roth conversion strategies depend on individual circumstances. Tax laws and regulations are subject to change. Please consult appropriate tax, legal, and financial professionals regarding your specific situation.