For many retirees, the years between the last paycheck and the first required distribution are the lowest-tax years they’ll ever have. Here’s how some families use that window, and the trade-offs to weigh.
Most people spend their working years deferring taxes: contributing to a 401(k), letting the IRA grow, and putting off the tax bill until later. Then retirement arrives, and “later” starts to look complicated. Required distributions, Social Security, and investment income can all stack up and push income higher than expected.
A Roth conversion is one of the more common ways people try to get ahead of that. It isn’t right for everyone, but it’s worth understanding.
How a conversion works
A Roth conversion moves money from a traditional IRA or 401(k) into a Roth IRA. The amount you convert is added to your taxable income that year. In exchange, the money in the Roth can grow and can potentially be withdrawn tax-free later, assuming the satisfying of several provisions, and Roth IRAs don’t have required minimum distributions during the owner’s lifetime.1
Why timing matters
The cost of a conversion depends on your tax bracket the year you do it. For many people, income dips in the years after they stop working but before Social Security and required distributions begin. Required distributions now start at 73 for people born from 1951 to 1959, and at 75 for those born in 1960 or later.2 That stretch can last five years or more.
Required distributions start at 73 for people born 1951 to 1959, and at 75 for those born in 1960 or later.
Q3 Advisors, citing current law
Converting a little each year during that window, enough to fill a lower bracket without spilling into the next, is often called “bracket filling.”
The trade-offs
What a conversion can and can’t do Common benefits, and the costs that come with them. | |
Taxes | Pay now to avoid paying later It only helps if your tax rate now is lower than it would be when the money comes out. |
Future distributions | Smaller required withdrawals A lower traditional IRA balance means smaller required distributions later. |
Medicare premiums | Watch the two-year lookback A large conversion raises income, which can increase Medicare premiums two years later. |
Heirs | Roth money can pass more cleanly Heirs generally still have to empty an inherited account, but Roth withdrawals are typically tax-free. |
The five-year rule | Each conversion has its own clock Withdrawing converted money too soon can create penalties or taxes in some cases. |
Educational information only, not tax advice. Whether any strategy fits depends on your full situation. Talk with your CPA first. | |
Questions worth asking
– What’s your bracket now versus later? The whole case rests on this comparison.
– Can you pay the tax from outside the IRA? Paying the tax from savings keeps more money growing in the Roth.
– How much is too much in one year? Spreading conversions over several years usually avoids jumping brackets.
– Does it fit your estate plan? If the money is likely to go to heirs, their tax brackets matter too.
Where I come in
I don’t prepare tax returns. What I do is model how conversions could play out over several years alongside a client’s income plan, then bring the numbers to their CPA to confirm what makes sense before anything is done.
Recently retired or about to be? Let’s look at whether your conversion window is open.
About the author Matthew Holbrook, CFP® Coastline Wealth Advisory of LPL Financial | Newport Beach Matt has spent over 2 decades helping families, business owners, and professionals coordinate their investments, taxes, and estate plans. He works directly with each client and their CPA and attorney, so every decision pulls in the same direction. |
Sources
1. NerdWallet, Roth IRA Conversion: Rules, What to Know.
2. Q3 Advisors, The Roth conversion window before RMDs.
Important Disclosures
Matthew Holbrook is a registered representative with, and securities and advisory services offered through LPL Financial, a registered investment advisor, Member FINRA/ SIPC. LPL Tracking #1187500.
This material is for general information only and is not intended to provide specific advice or recommendations for any individual. LPL Financial and its representatives do not provide tax or legal advice. Please consult your tax advisor or attorney regarding your specific situation.
Roth contributions offer tax deferral on any earnings in the account instead of immediately lowering taxable income. Qualified withdrawals of earnings from the account are tax-free. Withdrawals of earnings prior to age 59 ½ or prior to the account being opened for 5 years, whichever is later, may result in a 10% IRS penalty tax. Limitations and restrictions may apply.
To qualify for tax-free withdrawals, you must generally be age 59½ and hold the converted funds in the Roth IRA for at least five years. Each conversion has its own five-year period, and early withdrawals may be subject to a 10% penalty unless an exception applies. Income limits still apply for future direct Roth IRA contributions.