Roth Conversions: How to De-Tax Your Retirement

Simply put, a Roth conversion is the movement of funds or assets from a tax-deferred account (ex: Traditional IRA, 401(k), 403(b), SEP IRA, etc.) to an after-tax account, such as a Roth IRA or Roth 401(k). In doing so, the value of the “conversion” is added to your taxable income for that calendar year. Before we go further, we should first reiterate the immediate tax implications of doing a Roth conversion. If you convert $100,000 from your Pre-tax account to a Roth account, then $100,000 will be added to your taxable income for that calendar year. While Roth conversions can be beneficial in the long-term, careful consideration and planning must be done before execution to ensure your retirement goals are met without an unplanned-for tax liability.

Roth conversions should be done when you have reasonable certainty that effecting a Roth conversion will increase the longevity of your retirement investments or savings. Careful consideration and planning must be done before executing a Roth conversion to ensure that your retirement goals are met without an unplanned-for tax liability.

So, why convert?

1. Tax-Free Retirement Income

With a Traditional IRA you might benefit from the immediate tax deduction on your contributions, but you will have to pay taxes upon receiving distributions. You are also required to take annual minimum distributions from your pre-tax Traditional IRA (Required Minimum Distributions or RMDs) beginning at age 73. Conversely, by completing a Roth conversion you are taxed now on the amount converted, but not taxed down the road. Assuming you have met all requirements, Roth account distributions are not taxable. Likewise, Roth accounts are not subject to an annual Required Minimum Distribution.

2. Tax-Free Growth

Once funds or assets are converted to an after-tax account, not a single penny of future capital gains or dividends and interest will be taxed again (assuming all Roth IRA conditions are met). You can even receive distributions from your Roth account tax-free. One of our favorite sayings is, “It’s not what you make; it’s what you keep”, meaning your investment return is only as good as it post-tax. Investing inside of a Roth account allows you to keep more of what you make.

3. Leave a Larger Legacy

In light of keeping more of what you make, choose which account type a beneficiary would prefer to inherit: A) a tax-deferred type of account where distributions are taxed, or B) an after-tax Roth account that is that receives tax-free treatment of growth and withdrawals. If we follow averages, most of us will pass away in our 70s or 80s - right when our heirs are in their peak earning years. With a tax-deferred account, your beneficiaries may be required to receive annual Beneficiary Required Minimum Distributions over a 10-year period. The withdrawn monies are added on top of their regular income – during their highest earning years – which could push them into a higher tax bracket. This is not an issue with Roth accounts, assuming the holding requirements are met.

4. Lessen the Effect of Future Tax Law Changes

Our current tax rates were set by the Tax Cuts and Jobs Act of 2017, which is set to expire on January 1, 2026, unless Congress acts to extend them. In 2026, tax brackets are poised to increase by 0% to 4% each. If you have converted assets from tax-deferred accounts to after-tax Roth accounts, this change will have a smaller impact on you since future distributions from your Roth account are not taxed either way.

No Income Limitations: While there is an income limit on the ability to contribute directly to a Roth IRA, there is no income cap on Roth conversions. Anyone, even high-income earners, can convert their assets to a Roth account.

Roth Conversion Strategies:

1. Fill Up Your Tax Bracket

Using this strategy, you convert enough of your Traditional IRA to a Roth IRA to reach the top of your current tax bracket. For example, if you are single and earn $150,000 in 2024, you are in the 24% tax bracket. If you convert $41,950 ($191,950– $150,000), you will still stay within your current 24% bracket.

2. Spread Conversions Over Multiple Years 

With this strategy, Roth conversions are broken up across multiple years, usually with smaller amounts each year compared to the lump sum conversion, to manage the tax liability and potentially reduce the overall tax you pay for the conversion.

3. Convert Undervalued/Depressed Investments

One of the best times to take advantage of a Roth conversion is when the market is down, causing your investments to lose value. You can convert the same asset but have a lesser tax liability since the asset is lower in value, while still receiving the tax-free treatment of potential future growth.

4. Back-Door Roth Conversions

The current income cap to be eligible to contribute directly to a Roth IRA is $161,000 Modified Adjusted Gross Income (MAGI) for single filers, and $240,000 MAGI for married joint filers. If you wish to contribute to a Roth account but are ineligible because of income limits, you can contribute to a Traditional IRA then convert to a Roth IRA. This strategy allows high earners to still fund a Roth IRA even when they can no longer make regular direct contributions to the Roth account.

5. Offset Tax Liability Via Charitable Gifts

The tax liability incurred when effecting a Roth conversion can often be offset or reduced by charitable gifting. Careful planning must be done to properly select the type of assets, the amount of the assets, and the type of charity. You can also front-load charitable gifting by using Donor-Advised Funds, which may be beneficial if converting a large amount of assets into a Roth account at one time.

Why You Should Work with a Trusted Wealth Advisor:

1. Roth Conversion Planning

Roth conversions should be part of a broader plan, not done in a vacuum. You must consider all sides of the Roth conversion equation, and you should not ignore the immediate tax implications. A trusted wealth planner can help you identify common pitfalls, decide how much and when to convert, and can provide a comprehensive plan of action. Roth conversions should be done when you have reasonable certainty that effecting a conversion will increase the longevity of your retirement investments or savings, and a financial planner can help guide you towards that reasonable certainty.

2. Discerning the Tax Liability

Your wealth advisor can derive what your tax liability should reasonably be prior to effecting a Roth conversion. Selecting which funds to use to cover the tax liability of your conversion, and advising whether or not to use charitable gifts to help offset some or all of the taxation are two areas a trusted wealth advisor should be able to offer pivotal guidance.

3. Impact on Other Income

Adding the tax impact of a Roth conversion to your other income sources may increase the taxation of your other income. For example, Social Security benefits can be taxed at several different tax rates, and a Roth conversion might make your benefits subject to a higher tax rate. Also, Medicare Part B & D premiums may increase due to Roth conversions done in prior years.

4. “Trapdoor” Roth Conversions

If your Traditional IRA contains any non-deductible contributions, those contributions will be taxed again upon conversion to a Roth IRA. This results in double taxation on those monies, hence the “trapdoor” name. It is imperative to work with an advisor that can identify any non-deductible assets, and account for any double taxation in the convertible amounts proposed.

5. Understanding Roth Account Requirements

A financial planner can help you navigate the legal requirements of maintaining a Roth IRA. Rules must be followed to receive tax-free distributions of capital gains, which include the age you must be, the number of years the Roth IRA has been established, and the length of time your monies have been in the Roth account. A financial planner will help make sure you have de-taxed your retirement properly.

While there are several nuances to the process, we believe taking advantage of Roth conversions can help bolster your wealth planning and increase the longevity of your retirement investments. Navigating the various obstacles and tax pitfalls can be time consuming, which is why we always encourage individuals to utilize the expertise of a trusted wealth advisor to help make these crucial decisions.

To learn more about how a Roth conversion can help you grow your wealth, contact one of our trusted advisors.