The Middle Ground on Roth Conversions

Most people are going to end up somewhere in between, where converting to a Roth can make a lot of sense but only up to a certain point.

Roth conversions make the most sense when you can choose to pay the income tax on your IRA balance and move it to a Roth in a relatively low-income tax year. “Relative” is an important word here because it is going to be unique to each taxpayer’s situation.

The question to ask yourself here is this: Am I concerned that, at some point in the future, I could be in a higher tax bracket than I am now?

Consider using this free tool to match with a financial advisor for professional guidance of your Roth conversion.

Roth Conversion Factors to Understand

If you decide a Roth conversion helps accomplish your wealth goals, there are several factors to keep in mind when deciding how much to convert in a particular year. They are:

How Much Income Tax Will Be Due

Generally speaking, the more we can spread out taxable income, the lower the federal income tax we will pay. That is an oversimplification. But it provides a starting point for thinking about how to put together a Roth conversion strategy.

In the example presented in this question, generally speaking, converting the full $1.4 million from an IRA to a Roth in a single year would result in more taxes paid than spreading those conversions over the remaining life expectancy of the taxpayers.

Other Tax Implications

Federal income tax gets all the attention when Roth conversions come up. But your marginal tax rate (the amount of tax you’ll pay on the next dollar of income) is hardly the only consideration.

In this example, 85% of the taxpayer’s Social Security (the highest amount possible) is already included in taxable income. But for taxpayers with lower taxable income, Roth conversions have the potential to change how much Social Security is taxable.

Increasing taxable income can also change a taxpayer’s eligibility for tax credits and deductions. For taxpayers who have not started claiming Medicare, the premium tax credit can be particularly impactful.

Medicare Premiums

For taxpayers approaching age 65 or already on Medicare, it is crucial to remember that the amount you pay for your Medicare is impacted by your taxable income (specifically through modified adjusted gross income) and can crank up the true cost of doing a Roth conversion.

This can be particularly dangerous because each income bracket for Medicare premiums is treated as a cliff. So once you are a single dollar over the threshold, your premiums take the full jump to the next level. In other words, in for a penny, in for a pound.

What If Tax Rules Change in the Future?

I often get asked whether I am concerned Congress will change Roth rules in the future and having large Roth balances could turn out to be a liability.

My answer is always the same: The tax code is written in pencil, and Congress can change anything it wants. We have to do the best we can with the information we have and the laws that are currently in place.

A financial advisor can help you navigate changes to legislation, including scheduled sunsetting of Tax Cuts and Jobs Act provisions in 2026.

What to Do Next

My crystal ball is still broken, so anything I say about future rule changes would just be a guess. What I do know is that holding an IRA is like having a variable-rate mortgage with the IRS where they have the ability to change the interest rate to whatever they’d like, whenever they’d like. An opportunity to take the IRS out of the picture by converting IRA dollars to Roth dollars is always worth considering.

Steven Jarvis, CPA, is a SmartAsset financial planning columnist and answers reader questions on personal finance and tax topics. Got a question you’d like answered? Email AskAnAdvisor@smartasset.com and your question may be answered in a future column.

Please note that Steven is not a participant in the SmartAdvisor Match platform, and he has been compensated for this article. Taxpayer resources from the author can be found at retirementtaxpodcast.com. Financial Advisor resources from the author are available at retirementtaxservices.com.

Find a Financial Advisor

• If you have questions specific to your investing and retirement situation, a financial advisor can help. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three vetted financial advisors who serve your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.

• Planning for retirement? Use SmartAsset’s Social Security calculator to get an idea of what your benefits could look like in retirement.

• Keep an emergency fund on hand in case you run into unexpected expenses. An emergency fund should be liquid — in an account that isn’t at risk of significant fluctuation like the stock market. The tradeoff is that the value of liquid cash can be eroded by inflation. But a high-interest account allows you to earn compound interest. Compare savings accounts from these banks.

• Are you a financial advisor looking to grow your business? SmartAsset AMP helps advisors connect with leads and offers marketing automation solutions so you can spend more time making conversions. Learn more about SmartAsset AMP.

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The post Ask an Advisor: We Are 70 Years Old, Have $99K in Retirement Income, a $1.4M IRA and Other Investments. Is It Too Late to Convert to a Roth? appeared first on SmartAsset Blog.