Does a Roth IRA Conversion Make Sense for You? Six Questions to Ask that Will Help You Make that Decision.

Roth conversions are strategies investors can use to help minimize their future tax bill and give them more potential control over their tax bracket. Click here to learn more about Roth conversions.

Lower-income years tied to a job loss, income reduction, significant income tax deductions, high levels of depreciation, business losses, or charitable giving could be reasons to look into Roth conversion opportunities before the end of the year.

This post contains six questions to help you determine if you should explore a Roth conversion opportunity before it expires on December 31st. Technically, the opportunity may expire sooner with Custodians like TD Ameritrade, who may request your paperwork earlier to complete the process by year-end.

While answering yes to any of the questions below could be a reason to pursue a Roth IRA conversion, you should consider completing a Roth IRA conversion analysis with a financial planner and talk to your accountant for tax advice before implementation.

Question #1: Do you have a significant amount of pre-tax money saved for retirement that could push you into an undesirable tax bracket?

Many high-net-worth individuals we work with project they will have millions of dollars in tax-deferred retirement plans, which may cause a tax problem. Retirement plans like 401(k)s, traditional IRAs, and 403(b) accounts are tax-deferred until the IRS forces you to withdraw money and pay taxes at age 72.

These forced withdrawals are called Required Minimum Distributions or “RMDs.” If you have a significant amount of pre-tax money saved for retirement or project that you will have a significant amount of money in tax-deferred retirement plans, a Roth conversion strategy could potentially help you. I recommend you read this post  if you think you may be in this situation.

Question #2: Are you in a lower income tax bracket this year?

If you’re in a lower income bracket this year and anticipate being in a higher bracket in the future, it could be an appropriate time to consider a Roth conversion. It’s never ideal to have a lower income, especially when you or your loved ones depend on it.

However, lower-income years can be some of the best years to consider Roth conversions!

For example, I’ve worked with individuals in a higher tax bracket who could not work due to a disability. With that drop in their income, we were able to convert a significant dollar amount in a lower tax bracket, which created a reduction in tax! Other income events that could result in favorable Roth conversion outcomes could include the following:

  • You (or your partner) lost your job
  • A temporary disability
  • You changed jobs or had an adjustment in compensation that will result in less income
  • Higher levels of charitable giving

Question #3: Do you think you’ll be in a higher tax bracket in the future?

One of the easiest ways to figure out what tax bracket you might be in in the future is to run some financial planning projections.

If you don’t have a financial plan, it could be challenging to analyze Roth conversion opportunities that could potentially lower your lifetime tax bill.

If you need help creating a financial plan, our process is just three steps:

  • Request a consultation
  • Let us customize your plan
  • Live your best life! We’ll help you stay on track so you can enjoy the wealth you’ve created, both now and in the future.

Are you wondering what a sample Roth conversion and retirement analysis look like? Check out this blog post to learn more.

Question #4: Do you have very little money in a Roth IRA or Roth 401(k)/403(b)?

In this scenario, you may have most of your assets in tax-deferred accounts. And, if most of your retirement income and nest egg are taxable at retirement, the government will have control over your effective tax rate.

However, if you have a sizable amount of money in a Roth IRA alongside your tax-deferred accounts, you may have options to strategically keep yourself in a lower bracket.

For example, let’s say your income withdrawals from your tax-deferred retirement account leave you at the top of the 24% tax bracket ($89,075 for individuals and $178,150 for couples). Let’s also assume you need $54,400 for a significant purchase (auto replacement, boat purchase, or a down payment on a retirement home.)

You would need to withdraw $80,000 from a tax-deferred retirement account because that withdrawal would push you into the 32% income tax bracket (up 8% from the 24% bracket you were in).

That $80,000 withdrawal would cause you to pay an extra 8% in taxes, and Uncle Sam would get an additional $25,600 in taxes ($80,000 * 32%!) Just imagine what that $25,600 could have grown to if you had left it in your account.

You won’t pay any income tax if you take that same $54,440 from a Roth IRA or Roth 401(k) as a qualifying withdrawal.

By converting tax-deferred funds into a Roth IRA, you’ll have assets that won’t be taxed when withdrawn as a qualified withdrawal, potentially allowing you to manage your tax brackets better and enable more personalized tax planning during retirement.

To learn more about different strategies to get funds in a Roth account, check out this blog post. This post also shows high-income earners how to get funds into a Roth when they exceed the income limits.

Question #5: Could your beneficiaries be in a higher tax bracket than you are today?

If your goal is to lower your family’s lifetime tax bill, you might consider looking into a Roth conversion opportunity. Here’s one example of how this strategy could keep more in your family’s pocket.

Suppose you are a single filer and make $100,000 after deductions, and you’re in the 24% tax bracket. And let’s also assume that one of your adult children does very well and is in the 35% bracket.

One option for you would be to do a Roth conversion. You could convert about $64,000 and remain in the 24% tax bracket. You could pay 24 cents on the dollar, and then you could pass that money to your adult child, who would pay 35 cents on the dollar in federal taxes. In a sense, this could potentially save them 11% in taxes. This strategy could also reduce your estate taxes (if you have a taxable estate).

Another benefit of doing that Roth IRA conversion is that your adult child can be eligible for tax-free earnings on their inherited Roth account.

Question #6: Could your Social Security benefits be taxed at a lower rate if you had more tax-free retirement income?

In a previous post, we covered a hypothetical scenario demonstrating how an individual could potentially pay $0 on their social security benefits. We also discussed how RMDs could increase taxes on your social security benefits, in addition to how to calculate the percentage of your Social Security income that may be taxable. Click here to read more about this topic in-depth.

Is there a way to potentially reduce the pain (i.e., tax hit) on the conversion?

I’m glad you asked! Three simple steps can reduce the potential pain of a Roth conversion.

We believe the first step to reducing uncertainty is to create a financial plan. History doesn’t guarantee anything, and neither do projections. But if you have a plan and we know your current tax rate, you might be able to remove some uncertainty around whether a Roth conversion might put you in a higher or a lower bracket.

The second step is coordinating potential Roth conversions with tax deductions and lower income tax years. While your financial plan is one component of the analysis, the other important piece is your tax deductions. We can run an analysis, look at the goals in your plan, and then provide strategic recommendations.

Before you implement any strategies, it’s essential to ensure that your advisor and accountant are working together and on the same page regarding the conversion amount, strategy, and any options being looked at.

The last step is implementing your strategy before the end of the year.

So those are six questions to ask to help decide whether a Roth IRA conversion is right for you. Roth IRA conversions don’t make sense for everyone. That’s why we believe it’s imperative to complete an analysis before implementing any conversion strategies.

Are you ready to see if you might be able to minimize your future tax bill?

Enter some basic information about your current situation in the Tax Minimization Assessment. It should only take a few minutes before you receive your results!

Do you need assistance completing a retirement distribution and Roth conversion analysis?

It’s easy to get started with just three simple steps.

  • Schedule your complimentary initial consultation
  • Let us customize your plan
  • Live your best life! We’ll help you stay on track so you can enjoy the wealth you’ve created, both now and in the future.