As we approach year-end, it’s a good time to evaluate whether converting some of your traditional IRA or retirement accounts to a Roth IRA makes sense. A Roth conversion can be a powerful long-term tax planning strategy, but the best decision involves more than simply comparing today’s tax rate with tomorrow’s.
The goal isn’t necessarily to pay less tax this year. It’s to create the best after-tax financial outcome over your lifetime and for the people who inherit your assets.
Key Factors to Consider
1. Your Current and Future Tax Brackets
Converting funds requires you to recognize the taxable amount as ordinary income in the year of conversion. If you expect higher tax rates in retirement, a future increase in income, or changes in tax law, paying tax now may be beneficial. Partial conversions can help manage how much income falls within a particular tax bracket without unnecessarily pushing you into a higher one.
2. Investment Returns: Pre-Tax vs. After-Tax Growth
One of the biggest advantages of a Roth IRA is the potential for future tax-free growth on qualified distributions. With a traditional IRA, investment growth is generally tax-deferred, but withdrawals are typically taxable. With a Roth IRA, qualified withdrawals—including investment earnings—are tax-free.
The key question is how the tax on your conversion is paid. If you pay the conversion tax using funds outside your retirement account, your Roth assets can remain fully invested and potentially grow tax-free for years. Over time, that growth may help offset the upfront tax cost. However, the outcome depends on investment returns, your tax rates now and in the future, how long the money remains invested, and what you would otherwise earn on the funds used to pay the tax. If you must withdraw retirement funds to pay the tax, the benefit may be reduced because less money remains invested for future growth.
3. Medicare Premiums and IRMAA
Higher income can trigger Medicare's Income-Related Monthly Adjustment Amount (IRMAA), increasing your Part B and Part D premiums. Medicare generally uses income from two years earlier to determine these adjustments. A conversion today could therefore increase Medicare premiums two years from now. We need to weigh that temporary cost against the potential long-term tax savings.
4. The Window Before Required Minimum Distributions (RMDs)
The years after retirement but before Social Security benefits and required minimum distributions begin can offer a valuable planning opportunity. During this period, income may be lower, creating room for Roth conversions at more favorable tax rates. Converting strategically before RMDs begin may also reduce future required withdrawals and the taxable income they generate. Remember, RMDs cannot be converted to a Roth IRA; any RMD due for the year must generally be distributed first.
5. The Surviving Spouse Tax Trap
Married couples filing jointly often benefit from wider tax brackets. After one spouse dies, the survivor may eventually file as single, with narrower tax brackets and potentially higher taxes on the same retirement income. Proactive Roth conversions while both spouses are living may help reduce future taxable distributions and provide greater flexibility for the surviving spouse.
6. Qualified Charitable Distributions (QCDs)
If you are age 70½ or older and regularly give to charity, a qualified charitable distribution directly from an eligible IRA to a qualifying charity may satisfy some or all of your RMD while keeping the distributed amount out of taxable income, subject to applicable rules and limits. Because Roth conversions increase taxable income and generally cannot be offset by a QCD from the same transaction, we should coordinate charitable giving and conversion strategies carefully.
7. Social Security Timing
The years between retirement and collecting Social Security may present an opportunity for lower-income Roth conversions. However, additional taxable income can also cause more of your Social Security benefits to become taxable once benefits begin. Coordinating conversion amounts with your planned benefit start date can help avoid unintended tax consequences.
8. Which Assets Will Pay the Tax?
A conversion creates a tax bill. Ideally, you have sufficient nonretirement funds to pay that bill without taking additional taxable distributions from your IRA or sacrificing the long-term growth potential of the converted funds. We should also consider cash flow, investment allocation, emergency reserves, and whether the money can remain invested in the Roth IRA for a meaningful period.
9. Legacy and Inheritance Planning
Roth IRAs generally offer tax-free qualified withdrawals and can be valuable assets to pass to beneficiaries. Many nonspouse beneficiaries must withdraw inherited IRA assets within 10 years, and inherited traditional IRAs may create substantial taxable income during that period. Inherited Roth IRAs generally follow the same 10-year distribution framework for many beneficiaries, but qualified distributions are typically tax-free. A conversion may shift the tax burden from your heirs to you, potentially at a lower effective tax cost.
The Bottom Line
A Roth conversion is not an all-or-nothing decision. Converting a portion of your retirement assets over several years may provide more control over tax brackets, Medicare premiums, future RMDs, charitable giving, and the wealth you leave behind.
The right strategy depends on your retirement timeline, income sources, other assets, health and longevity considerations, charitable intentions, investment outlook, and legacy goals.
Let's review your retirement picture before year-end. A well-timed conversion may create opportunities, but a conversion that looks attractive in isolation can be costly when its effects on Medicare, Social Security, investment growth, and other income-sensitive provisions are overlooked.
Contact Apel Advisory Solutions to discuss whether a Roth conversion—or a multiyear conversion strategy—fits your financial plan.
Planning note: Roth conversions are generally irreversible once completed, and the tax consequences can extend beyond the conversion year. Medicare thresholds, tax brackets, RMD rules, and charitable distribution limits should be verified for the applicable tax year before acting. This newsletter is intended for general education, not individualized tax or investment advice.