Roth Conversions for Retirement: What Nobody Prepared Disciplined Savers For

Roth conversions are a buzzword in financial services right now. If I have a meeting with a prospective client, I would bet any amount of money Roth conversions will be top two that they're going to bring up.

 

So why are Roth conversions such a hot button issue for retirees who've done a good job saving? Here's my take on it.

 

The Problem Nobody Saw Coming

 

Folks I work with who are approaching retirement today — or who have recently retired — have done a phenomenal job of saving in their company 401(k) plan. Most of them are 55 to 75 right now. They either never had a pension, or had a pension that transitioned to a 401(k) mid-career. They were really one of the first generations that had to save for retirement on their own.

And so what they did is they saved aggressively. They took those tax deductions by contributing to the pre-tax account balance inside their 401(k). They were disciplined with their savings and their budget throughout the course of their lives.

 

What nobody prepared them for is that building that account over the years — with market appreciation — to $2, $3, $4, $5 million in some cases, is going to result in massive required minimum distributions (RMD) at age 73. And if you were born after 1960, that RMD age transitions to 75.

Now they have a really big IRA (or IRAs for married couples) that's could generate $120,000 — maybe even $400,000 — of required minimum distributions each year. Typically, they don't need all that money. And they don't want to pay the tax on all of it.

 

So what are they to do?

 

Strategic Roth Conversions: The Earlier, the Better

 

The answer for many people is strategic Roth conversions — moving money from a pre-tax IRA into a Roth IRA and paying the taxes now, at today's rates, before RMDs force the issue.

The earlier you retire, the longer glide path you have to perform those conversions. If you work until 70 and your RMD starts at 73, you have a narrow window. You have to come up with a plan and decide how aggressively you want to convert. Typically, I'm focusing on conversions at the 12%, 22%, and 24% federal income tax brackets — and stretching that over as many years as possible.

 

One Critical Detail: Where the Tax Money Comes From

 

One of the problems people run into when they want to perform these conversions is having the money on the sidelines — whether that's in a bank account or a taxable investment account — to pay for the taxes on those conversions.

 

Some folks want to pay for the conversions out of their IRA itself. But then you're taking money out and owing ordinary income taxes on that money just to pay taxes with it. It really eats away at the potential benefit of the Roth conversion.

 

If you're approaching retirement or you already have a significant IRA balance, I would encourage you to build up that taxable investment account so that you can use it to pay for Roth conversions down the road. And if you don't end up performing any conversions, so be it — what you've done is diversified yourself from an account perspective and given yourself flexibility in retirement.

 

The Stealth Taxes Most People Don't See Coming

 

There are a number of things you have to look out for when you're thinking about performing Roth conversions. I call them stealth taxes.

 

Medicare IRMAA

 

One of the topics retirees are most sensitive to is how much their Medicare Part B and Part D are going to cost in retirement. What I'm referencing is the IRMAA surcharge — Income-Related Monthly Adjustment Amount — associated with your Medicare premiums. If you convert too much money in a given year, it can throw you into a higher Medicare bracket and increase what you pay in premiums.

 

Here's something important to keep in mind: Medicare premiums are on a two-year lookback. So if you convert $400,000 this year, your Medicare premiums aren't going to increase until 2028. Sometimes the numbers still justify paying more in Medicare for one year — but you need to model that out before converting.

 

Net Investment Income Surtax

 

Another stealth tax to watch: if you are married filing jointly and your income exceeds $250,000 in a year, you owe a 3.8% surtax on your net investment income. It's not a deal-breaker, but it's another variable that has to be factored into the analysis.

 

The Tax Rate Question

 

Determining whether a Roth conversion makes sense really does come down to your personal belief about where tax rates are headed.

 

I'm 35 years old. I'm of the belief that taxes are going to go up in my lifetime. If you're in the camp that taxes are going to stay where they are today — or even go down — then maybe a Roth conversion wouldn't be the best fit for you.

 

But if you look at tax rates across the history of this country, they're really pretty low right now. If you can convert at 22% or 24%, lessen the amount of RMDs you'll be forced to take over your lifetime, and hedge against the possibility that rates go up in the future — that's a meaningful set of benefits to consider. The TCJA tax rates were recently made permanent, but it's always possible that future legislation rewrites that. Something worth considering.

 

The Widow's Penalty: The Scenario Nobody Wants to Plan For

 

This is a very sensitive topic, and it's a conversation I have with many of my clients — well in advance, when both partners are in the room.

 

Here's what happens: when a spouse passes away, that is the last year the surviving spouse is able to use married filing joint tax brackets (unless they remarry in the future, of course). The following year, their expenses typically stay the same — but their tax brackets are now constrained to single filer rates, which are significantly narrower.

 

What I discuss with clients is this: if someone unfortunately passes away, we are going to consider performing a rather large Roth conversion in that calendar year. We don't need to map out every detail today, but it's something we need to plan for — in advance, not in the middle of grief.

 

Converting During a Market Downturn

 

The timing of Roth conversions can also work in your favor if you're planning ahead.

 

We had a client this year that we had already done the analysis for — we had a conversion number in mind for 2026 and were working toward it throughout the year. When the market started off volatile and certain positions were down, we cherry-picked positions in that client's account that were down and converted those funds into the Roth IRA.

 

What we've seen since: those positions have rallied and are performing well — all inside their Roth IRA — and they owed taxes on the smaller, down-market value at the time of conversion. This strategy may not always work as described above, as the converted positions could continue lower, versus rallying higher. However, that’s one strategy you could take advantage of if you're doing the planning ahead of time. It offers flexibility based on market volatility.

 

Is a Roth Conversion Right for You?

 

I'm very pro-Roth IRA. I love talking about Roth conversions. But what I'll admit is that it's not perfect for everyone and it may not make sense for you.

 

What I do believe strongly is this: if you have a pre-tax account balance greater than $1 million, you should at least have someone — yourself or an advisor — perform the analysis to see if the numbers make sense. There are a lot of rules to look out for. You want someone experienced in performing these so there aren't any surprises if you decide to move forward.

 

One important thing to know: there are no longer any recharacterizations on Roth conversions. Once you convert those funds, you can't undo it. So you want to make sure your analysis is tight and that you're in agreement with your financial team before you pull the trigger.

 

If you want someone who's done this hundreds of times to perform the analysis and give you the information to make an informed decision — we'd be happy to do that for you.

 

Bryce Edmister is a financial planner at Masonboro Advisors, an independent RIA based in Wilmington, NC. Fairways 2 Finance is his personal brand focused on proactive tax planning and financial education for individuals near and in retirement.

 

Investment advisory services are offered through Glasgow & Associates, LLC, d/b/a Masonboro Advisors (“Masonboro”), an investment adviser registered with the Securities and Exchange Commission. Additional information about Masonboro is available on the SEC’s website at www.adviserinfo.sec.gov. 

  

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