Roth Conversions: Looking Beyond Your Tax Bracket

A Roth conversion can be a powerful retirement planning tool, but the decision is rarely as simple as asking whether tax rates will be higher or lower in the future.

With a traditional IRA or 401(k), you receive a tax benefit when you contribute. Your investments can grow tax-deferred, but withdrawals are eventually taxed as ordinary income and Required Minimum Distributions (“RMDs”) apply later in retirement. A Roth account works differently. You contribute after-tax dollars, but your investments can grow tax-free, qualified withdrawals are tax-free, and Roth IRAs do not have lifetime RMDs for the original owner.

How a Roth Conversion Works

When you complete a Roth conversion, you move money from a traditional retirement account into a Roth and pay income tax on the amount converted. The challenge is deciding whether paying that tax today will leave you better off over the long run.

Comparing your current tax rate with the rate you expect to pay in retirement is useful, but it does not tell the whole story, especially for retirees. A conversion increases your taxable income and can affect the taxation of Social Security benefits, Medicare premiums through IRMAA, capital gains taxes, deductions, and state income taxes. Rather than focusing only on your tax bracket, you should consider the actual tax cost of the conversion and how it fits into your broader financial plan.

When Does a Roth Conversion Make Sense?

When should you look to convert? Some of the best times are years when your income temporarily falls. A common example is the period after you retire but before you begin Social Security or RMDs. Your paycheck has stopped, while other sources of taxable income have not fully kicked in. This may allow you to convert part of your traditional IRA or 401(k) at a more favorable tax rate.

Other favorable circumstances may include market downturns or years with unusually large deductions or charitable gifts. Temporary business losses or a change in state residency can also create an opportunity. A conversion may also make sense before an expected increase in your effective tax rate, such as a large raise, the start of deferred compensation, or a new source of income like a pension or annuity payout.

Managing RMDs and Taxes in Retirement

Roth conversions can become particularly valuable if you have accumulated a large balance in traditional retirement accounts. Eventually, RMDs can force you to recognize taxable income whether you need the money or not. Converting some of those assets earlier can reduce future RMDs and the taxable income they generate.

That flexibility can be useful throughout retirement. If most of your savings are in traditional retirement accounts, nearly every withdrawal creates taxable income. Holding a mix of taxable, tax-deferred, and Roth assets gives you more choices about where to take money from each year and greater control over your taxable income.

Roth Conversions and Your Estate Plan

Your estate plan may also factor into your decision. If you plan to leave an IRA to your children, they will generally have 10 years to fully distribute the inherited account. With a traditional IRA, those distributions are taxable and could come at a time when your children are in their highest-earning years. With an inherited Roth IRA, the money can generally remain invested and continue growing tax-free for up to 10 years, and qualified distributions are tax-free. By converting during your lifetime, you can effectively pay the tax yourself and leave your heirs an asset with more favorable tax treatment.

Ultimately, a Roth conversion is not an all-or-nothing decision. The right approach may be to convert nothing, make a larger conversion in an unusually favorable year, or spread partial conversions over several years. The goal is not simply to minimize taxes today, but to manage your tax burden over your lifetime. At Carnegie Investment Counsel, we can help you evaluate how a Roth conversion fits into your broader retirement and tax strategy.

For informational purposes only. The information is not intended to provide specific advice or recommendations,  and all investments involve risks, including the loss of principal.

Carnegie Investment Counsel (“Carnegie”) is a registered investment adviser with the Securities and Exchange Commission. Registration as an investment adviser does not imply a certain level of skill or training. For a more detailed discussion about Carnegie’s investment advisory services and fees, please view our Form ADV and Form CRS by visiting: https://adviserinfo.sec.gov/firm/summary/150488.

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