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IN RECENT YEARS, I’ve confronted a choice: I could fund my solo Roth 401(k)—or I could use the dollars to cover the tax bill on a large Roth conversion. I wish I could do both. But after using my earned income to pay living expenses and make financial gifts, I don’t have the necessary cash.
My choice: Go for the big Roth conversion.
Why? In part, it’s because I’m focused on shrinking my traditional IRA before I turn age 75 and have to start taking required minimum distributions (RMDs), which could push me into a much higher federal income-tax bracket. I’m especially focused on doing so in 2024 and 2025.
In early 2026, I’ll turn age 63, which means thereafter any Roth conversions have the potential to trigger the Medicare premium surcharge known as IRMAA, or income-related monthly adjustment amount, which is based on your income from two years earlier. On top of that, it’s possible federal income-tax rates will climb in 2026, assuming the individual tax cuts included in 2017’s Tax Cuts and Jobs Act are allowed to sunset.
But there’s an added reason to favor Roth conversions over contributing to my solo Roth 401(k). Suppose I have $24,000 in spare cash. I could stash that $24,000 in my solo Roth 401(k), which is appealing.
But it isn’t as appealing as using the $24,000 to cover the federal income-tax bill on a $100,000 Roth conversion. This assumes I’m in the 24% federal income-tax bracket. In other words, a Roth conversion gives me more bang for my buck, allowing me to get a bigger chunk of money growing tax-free, plus it means smaller tax bills down the road because it shrinks my traditional IRA.
My plan is to leave my Roth accounts to my two children. One is likely to be in at least as high a tax bracket as me, so it makes sense for me to pay my IRA’s tax bill instead. In fact, I may tweak the beneficiaries on my Roth and traditional IRAs, leaving more of my traditional IRA to the child in the lower tax bracket.
There’s also some possibility that I’ll tap my Roth accounts for my own use—if, for instance, I have a year with surprisingly high expenses and pulling yet more money from my traditional IRA would push me into a much higher tax bracket. On the other hand, from a tax perspective, my traditional IRA could also come in handy, notably for charitable giving and if I have a year with high deductible medical costs that I could offset against a traditional IRA withdrawal.
What if—unlike me—you’re fully retired and don’t have any earned income, and hence you don’t face the choice of either funding a Roth or converting part of your traditional IRA to a Roth? If you have taxable-account money to cover the conversion tax bill, it may still be worth making a big conversion.
Before you go ahead, there’s all manner of considerations, including the rate at which the conversion will be taxed, your projected tax bracket once you begin RMDs, and the potential impact on your IRMAA premium surcharges and on the taxation of your Social Security benefit. If you intend to bequeath your Roth accounts, you might also ponder your tax rate compared to that of your beneficiaries. In addition, you should consider whether you can pay the conversion tax bill without triggering additional taxes because, say, you’d have to sell highly appreciated stock to generate the cash needed to cover estimated taxes.
But as with my annual choice, keep in mind the leverage involved—that every $1,000 in extra income taxes paid will allow you to get many multiples of that sum shifted out of your traditional IRA and into a Roth, where it’ll then grow tax-free. Moreover, this maneuver has a little-appreciated advantage: By using taxable-account money to cover the tax bill on a Roth conversion, you thereafter avoid the tax bill on that taxable-account money.
Suppose you have $10,000 in a high-yield savings account that’s earning 5% in annual interest, or $500 a year. If you use that $10,000 to pay the conversion tax bill, not only will you move a big chunk of money into a tax-free account, but also you’ll no longer have that $500 a year in taxable interest.
Indeed, by using that $10,000 to pay the tax bill on a Roth conversion, it’s like you’re shifting the $10,000 into your Roth, where it will then grow tax-free. The tax savings from shrinking your taxable account is the reason it’s worth undertaking Roth conversions, even if you think your tax bracket in future will be similar to what it is today.
For those with greater wealth, there’s an added incentive to “prepay” the income taxes owed on their traditional retirement accounts: The net result is to reduce the size of your taxable estate. That could mean not only a smaller federal estate-tax bill—not a problem for the vast majority of families—but also less in state inheritance and estate taxes, which are an issue in a third of states, including where I live.
Jonathan Clements is the founder and editor of HumbleDollar. Follow him on X @ClementsMoney, on Facebook and on Threads, and check out his earlier articles.
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I would hope that you are taking into account the time value of money. If paying taxes bothers you so much it might be better to pay the taxes little by little over the next decade until the time you are required to take out those tax deferred $ from IRAs and tax deferred 401Ks. Take out a measured amount from tax deferred account(s) on a yearly basis so you reduce the amount you have at the commencement of your RMD withdrawal period while at the same time not taking out too much each year that you jump into a higher tax bracket. The IRS likes your strategy I’m sure but it would seem to be better to defer paying those taxes as long as you are able.
I find your reference to the time value of money puzzling. Do you appreciate that it can be more valuable to have a smaller sum growing tax-free than it is to have a somewhat larger sum growing in taxable and tax-deferred accounts?
I find it puzzling that you would want to pay a sum of taxes upfront rather than over a period of years to allow tax deferred funds to grow over time. You say that you are worried about being pushed into an income level where your medicare tax is higher. In your column you say that you are worried about taking RMDs which could put you into a higher tax bracket. Most people have the majority of their funds in tax deferred accounts because it allows them to save more than investing in something like a Roth. From your response it appears that you must have a relatively high % of your retirement funds in taxable and Roth accounts. I appreciate that it can be more valuable to have a smaller sum growing tax-free than it is to have a somewhat larger sum growing in taxable and tax-deferred accounts, but only if your mix of tax deferred vs tax-free and taxable is relatively even. Most people try to invest as much as they can over time and the best way to do that is to use tax deferred accounts whenever possible.
If converting to a Roth and paying taxes now results in greater after-tax wealth down the road, which is the case for me and many others, why wouldn’t folks do so?
I did lots of calculations and what-ifs. Eventually, I went with the easiest that made the most sense. Convert annually until RMD up to the max of the lowest MAGI. For a couple, it’s $206K.
When you have money, you will pay more, I rather have this “problem” than not 🙂
I “bit the bullet” in 2020 and 2021, making $100,000 Roth Conversions in both years, and paying @$24,000 each time. The result is today, 58% of my portfolio is Tax Free, 30% is Tax Deferred, and 12% is Taxable.
The RMDs I have been required to take in the last 2 years were taken as QCDs. In 2024 I am retired and I was able to fund two final Roth contributions from my final paycheck, earned in 2023 but received in 2024, along with a pay out for my accrued PTO.
One thing is certain, making the Roth Conversion decision is not a simple one. For most it will probably make sense, but there is value in having some qualified dollars in your portfolio later in life, should you incur Long Term Care expenses.
Great Article Jonathan.
Jonathan, I’m in the process of doing much the same as you, although the timing is a little skewed in your favor. I’m planning on retiring in 2026 when I turn 68, then not having much if any earned income for 2 year and using that 2 year span to do major Roth conversions and get my traditional IRA balances down as much as possible. At age 70 I’ll start claiming Social Security and start using as much from my IRA’s as I need, whether it is from the Roth or the traditional. I’ve hired an adviser to keep me between the rails on all of this IRMAA, SS, and other rules that the IRS has. I feel I’m pretty good at finances—been putting 100% of my 401k contributions into Roth for several years now in spite of the pain of paying taxes upfront. A lot of this post-retirement stuff is brand new to me and I don’t mind paying for someone who can help me through it.
– “been putting 100% of my 401k contributions into Roth for several years now in spite of the pain of paying taxes upfront.”
Same here. My tax guy thinks I’m a fool (going to “lose money”), but I’ve got money to pay the taxes and tax minimization as an absolute doesn’t always make sense except for those at the margins.
Great article. One question: 401K offers instituitional shares. IRA’s offer retail shares. The difference in fees could be 0.34% a year. Has anyone looked into this? See link
https://www.employeefiduciary.com/blog/401k-rollover-mistake
I started ROTH conversions after I retired at age 60 and my salary dropped off. I do the conversions to fill the 24% federal tax bracket. Since I am fortunate to have accumulated a substantial 401k balance, (converted to IRA after retirement because the 401k plan didn’t allow Roth conversions) I estimate to be in 32% or higher tax bracket once I start collecting Social Security payments at age 70 and RMDs at age 73. I pay the conversion tax from taxable account dividends. Even if I don’t see the benefit of conversion in my lifetime, my daughter, who is a high earner, certainly will.
Roth till it hurts or bumps you into higher IRMAA brackets. Of course congress will come after it but it is another layer they need to breach.
Congress may indeed come after Roths. But I imagine there would be grandfathering, as we’ve seen with other tax provisions.
Another way to pay the taxes on a Roth conversion is to use inherited Roth account proceeds. I am fortunate to have this source of tax free cash. Thus I am saving taxes which would be due from selling assets in a taxable brokerage account.
A short addendum on my just posted note…. I believe it’s important to project what you annual budgetary needs are vs your projected RMDs. If your IRAs are very large (and excessive) to your RMD needs, then of course this makes the case for IRA to Roth Conversions.
Another great article Jonathan! Your article inspired me to do some calculations on what will happen if current tax rates “sunset” YE2025. Like many retirees, my mortgage will be paid off, and although I will benefit from more liberal treatment of SALT (state and local taxes), the standard deduction will be reduced by almost 50% and federal tax rates will radically increase. I just did some “back of the envelope analysis.. I paid $41,000 in Federal taxes on an AGI of $260,000 in 2023 with current tax rates. Using same AGI in 2026 (and assuming current tax rates “sunset”), I would have a reduced standard deduction (from $32,000 to $22,000) and my Federal taxes would increase by roughly 25% to $53,000. Of course, Biden is saying if he is reelected he will not increase taxes (and therefore Congress would need to pass a new tax bill to handle 2026+). Will this happen? Probably, but certainly not guaranteed! To me, future tax rates are by far the biggest “wild card” in this conversation on whether to do an IRA to Roth conversion. If tax rates stay the same, it is one set of arithmetic. If current tax rates expire, than doing IRA to Roth conversions becomes much more of a “no brainer.”
– “Biden is saying if he is reelected he will not increase taxes”
Are you talking about Joe Biden? If he said that, he’s going against party orthodoxy and no one believes him. I’m amazed he ever said it. Are you sure he didn’t say he won’t increase taxes except for the rich? If so that’s a denial of the reality of taxation.
Great article on the many variables of a conversion. One other factor for consideration. If the Roth is a family planning tool, let’s assume you have 20 years to live. And, let’s further assume that the Roth goes to a beneficiary. Assuming the tax laws are stable, which is a big assumption, the beneficiary (after inheriting) has another 10 years to get tax free returns from the Roth. If you have 20 years to live, that is potentially 30 years of potential tax free appreciation for the family member(s).
“I may tweak the beneficiaries on my Roth and traditional IRAs, leaving more of my traditional IRA to the child in the lower tax bracket.” – Genius!
Another Roth conversion factor to consider for some is the reduction in Premium Tax Credits for health insurance obtained through the ACA Health Insurance Marketplace – effectively, an 8% tax on every dollar converted.
I think early retirees have a choice — either go small, in terms of income, to get the premium tax credit, or go big and do some serious Roth conversions. Which is better will obviously depend on personal circumstances.
We went small until we both turned 65 by the end of last year to receive the maximum premium tax credit for our ACA insurance policy (it was a quite unpleasant experience to start paying our monthly federal and supplemental insurance premiums after four years of “free health insurance). Over the next two years we are going big in Roth conversions this year and next, but not exceeding the 12% tax bracket.
I don’t know if my logic makes sense but I’m converting up to the end of the 12% tax bracket since my “effective” tax rate was 20% with the premium tax credit reduction. I couldn’t justify converting at a 30% rate (22% fed inc tax rate plus 8% ptc reduction).
this and next year might be the last opportunity to go big before the subsidy cliff disappears.
I coverted last 5yrs about $420k for LTC if ever needed in the 18-20% effective tax rate and now worth about $725K
???-Would it be prudent, age 74,73, to lock down those funds in laddered CDS thus guaranteeing no losses and reasonable tax free growth
Thanx!
This a wonderful exercise, but we should all be aware that there are a number of variables involved (remaining lifespan, marginal tax rate, other assets, market performance, etc.) over which we have no control and which, if they don’t work in our favor, could undermine the goal we think we are trying to achieve.
As long as current tax law allows people to make these conversion, many people will. However, I also expect that a fair number of people who have made this conversion will not be satisfied with the results – especially if they are dead!
For me personally, tax law allowed me to accumulate a considerable amount of money on a tax deferred basis and I am not particularly bothered about paying the taxes I have avoided during this process.
– “a considerable amount of money on a tax deferred basis”
It all depends on what you value. I only value money that I’ll actually be able to use or pass on one day so the total of a tax deferred account is a chimera.
While the benefit of a conversion may not matter to a dead person, it may matter to alive beneficiaries, especially if they are high earners and thus in high tax brackets.
I’m of the same mind, UofODuck. The tax laws generously enabled me to invest with pre-tax dollars into 403b accounts, obtain tax deductions for regular IRA accounts, and to grow assets tax-free. Barring unforeseen changes and circumstances, tax laws and RMDs should also assist with charitable giving in future years. I feel well-served and privileged.
I would love to do ROTH conversions on 2/3 of my savings containing traditional IRAs. But I am currently in my highest earning years and the taxes would kill me. Since I intend to work for 5 more years when I turn 72 there won’t be any low income years for me to do the conversions before I have to take RMDs. I am struggling now with figuring out whether to suck it up and pay for the conversions now or wait.
We’ve been on ACA for the last 2 years, live in a high tax state, and my younger wife will still be on ACA for 8 more years after I start Medicare this year.
Between the high state tax and ACA premiums that can swing from $0 to $12,000 per year based solely on MAGI income, it makes the ROTH conversion math hard to justify for us.
Word to the wise – it may be more cost effective to do ROTH conversions when you’re still working if you think you’re going to need to use ACA for healthcare to bridge the time to Medicare.
and then we are faced with maybe next year being the last year without the subsidy cliff
If anybody has been thinking about doing a solar panel install and a Roth conversion, this might be a good time to do both. You get a 30% federal tax rebate for the cost of any solar panel system install. Those tax credits can be used now or saved to offset future taxes. There are other energy relayed 30% rebates (upgrading your electrical service to 200 amps, more insulation or better windows…) but those credits have to be used in the same year. Those credits should be used first before the solar credits.
I’m in the middle of a solar install now and I’m planning on using the credits to pay for a Roth conversion this year. I still have to do the math to figure out how much to convert. Between SS and my pension my gross is around 58K. The rebate from my install should be around 10K.
Reading your comment I wonder if your income is at the level where every dollar of additional taxable income causes an additional amount of your social security benefit to become taxable. Mine is and currently each additional taxable dollar causes $0.85 of our social security benefit to become taxable. That makes my 2024 marginal tax bracket 18.5% for conversion dollars in the 10% tax bracket (10% x 1.85) and 22.2% for conversion dollars in the 12% tax bracket (12% x 1.85).
I put in a high efficient HVAC system that qualified for a great tax credit over a decade ago but the credit was a bonus as our old system had failed and that was before I retired and before I claimed social security.
My wife and I are now at an age and health status where I am uncertain how long we will be able to stay in this house and benefit from the cost of a high dollar solar system net of the related tax credit. I have no idea how the solar decision would benefit the value of our home relative to the cost.
For 2024 planning I like the free AARP online tax calculator to do what ifs on our tax planning. Maybe that calculator could help your planning.
I hope the solar installation goes according to your plan. I think if we were a lot younger I would consider doing the same. I did look into a geothermal HVAC when I did our last HVAC rebuild but we had two in college at the time and the cash flows just did not work at the time for us.
Best, Bill
As usual, thank you for highlighting the complexity and various factors to consider. Jon, you and I are almost the identical age which makes some of the comparison determinations easier (to a degree). All in all a good problem to have, but optimizing the situation is a challenge.
Good choice. I faced a similar decision about conversion just before I had to start RMDs. I played around with all sorts of Excel simulations for a week.
I finally decided that one should do a Roth conversion early, and I was probably too late. One needs to leave enough years for the tax-free appreciation in the Roth account to overcome the tax hit from the conversion, and the loss of the taxable returns that you could have gotten from that money in your IRA. There is a probably a cross-over point for that decision. For me, I think it would have been 5-6 years earlier.
Another point is to take an in kind conversion of a “down” stock from your Traditional IRA to your Roth, That way, assuming the stock recovers, you realize future gains tax free, as well as future dividends. Gains and dividends now in the Roth could eventually cover the tax dollars invested in the conversion.
Yes, this is an example where “market timing” might actually make sense.
i am a couple of years older than Jonathan, so i may have to suck it up with IRMAA premium impacts but i am trying to make some very significant conversions this year and next (taking advantage of the 22-24% brackets that may go away).
I converted about $100k worth of stocks 2 weeks ago during the late April downturn. My recently converted Qualcomm position surged more than 10% after that move.
You never know how those things will turn out, but I see every downturn as a conversion opportunity. I had multiple opportunities in 2022 😩
there are some very good sites with discussion of all of the relevant details; most sites ignore IRMAA, but the added taxes can be substantial
here is one of the best I found in quick search
https://www.kitces.com/blog/using-systematic-partial-roth-ira-conversions-and-recharacterizations-to-fill-the-lower-tax-bracket-buckets/
Unfortunately most “calculators” ignore IRMAA and the ObamaCare tax. Having said that, I did find a calculator that takes everything into account
https://www.newretirement.com/retirement/roth-conversion-calculator/
However, all estimates are based on today’s IRMAA thresholds, but your aftertax income this year will not affect your IRMAA until 2026, and the thresholds may change.
Still for most people the additional income tax is much higher than the additional IRMAA
Also, IRMAA takes into account tax exempt income. I usually wait until December when I have a better idea of dividend and interest income.
This is a very complicated topic where “one size does not fit all.” I’ve been converting our IRA balances to Roth for the last several years. Some fundamentals that I use to drive my decision making:
1)When will my wife and I take SS/RRB and how much
2)How much self-employment income will I have.
3Estimate of interest/dividend/capital gains income
4)Model impact of RMD’s for me and spouse
My goal is to optimize conversion on balances prior to SS/RRB and RMD’s. Another wildcard is the expiration of TCJA in 2026.
I stagger my conversions during the year as my self employment income is highly variable. If I did not have this issue I would convert on Jan 1.
Great article Jonathan! This topic is very relevant to many considering that the TCJA is set to sunset after 2025 tax year barring legislative changes.
BTW, the article you linked to comparing the TCJA to the prior tax law was excellent. Previously, I did an analysis of my own situation and the information was not all in one place and it took time to do the analysis. The article will help people do their own analysis more quickly.
When I retired in 2010 at age 66, I decided not to do the Roth conversions due to the added costs. A few years after TCJA was implemented, I decided to do Roth conversions since there was high probability (IMO) that the law would sunset and we would be looking at higher taxes along with high RMDs. I converted up to the maximum of IRMAA tier 2 which took me into 24% tax bracket. The extra cost was not bad and I have converted from 89% TIRA to 19% TIRA. I want to retain some money in TIRA for CDS so I no longer have to trigger IRMAA or higher tax brackets. Yeah!
Our investments in Roth, TIRA and taxable will mostly be inheritance for our children and grandchildren because we live off of pensions and SS.
Tax planning is extremely important and many people do not give it the consideration it needs. Thanks again.
IRMAA doesn’t last forever, if after the conversions your taxable income falls back to the safe zone. Isn’t this true?
It will be two years later. 2025 IRMAA will be based on your 2023 tax return.
Yes. But what isn’t mentioned here is that if your income is high 2 years before claiming Medicare, and you are now retired, let them know and the extra premiums will be waived. I did this and it was very easy. The first step is getting familiar with the Medicare Income-Related Monthly Adjustment Amount-Life-changing Event form (SSA-44). This form is your key tool for appealing an IRMAA decision.
Roth conversions are not qualified life changing events (SSA-44). Earnings changes such as retirement can be considered.
Correct. However, if you time conversions to coincide with a qualifying event in the same year (like retiring or reduced work hours) “bingo” you can get the IRMAA premiums waived.
i speak from personal experience. It works, just need to navigate the paperwork.
Interesting. I was planning on doing a larger Roth conversion the year I retire because I’ll only work 5 months of it, which is just long enough to get my 401-Roth maxed out. Could I use that excuse even if it turns out my AGI doesn’t drop after retirement because I take more cap gains? Is it just a life even regardless of the consequences? I don’t get it.
I recall clipping an article of Jonathan’s in the WSJ, circa 2001, entitled something along the lines of “The Roth Triumphs Over the Long Run.” I continued to run the numbers over the years but delayed taking the plunge until 2010 when I finally made a mega-conversion of my entire Rollover IRA. In that year, Congress – for once – presented a seemingly irrestible opportunity: convert in 2010, pay nothing in conversion taxes in that year, and spread equally the tax liability over the 2011 and 2012 tax years. Wow. One of the best financial decisions I have ever made (the tax-free growth has eclipsed the actual tax payments). So I hope Jonathan you will accept my [outrageously belated but nonetheless sincere] thanks.
Here’s Jonathan’s excellent article from 2001. If it shouldn’t be posted, please delete it. (P.S. You have a great memory!)
Wall Street Journal / September 9, 2001
Why the Roth Wins In the Long Run
By JONATHAN CLEMENTS
Staff Reporter of THE WALL STREET JOURNAL
It’s a battle of investment heavyweights.
In the early going, the edge belongs to the tax-deductible individual retirement account, while the Roth IRA offers no immediate tax savings. Still, the Roth may be a better bet to go the distance.
Once retired, Roth investors don’t owe anything to Uncle Sam, while regular IRA investors must pay income taxes on their withdrawals. And the Roth’s advantages don’t stop there. Consider:
Running the Numbers
Suppose a husband and wife both invested $2,000, each buying the same stock. The wife buys her shares in a Roth, while the husband invests through a tax-deductible IRA. Because the couple is in the 28% tax bracket, the husband’s $2,000 contribution garners a $560 tax deduction.
To have any hope of keeping up with his wife, the husband must invest the $560, which he uses to buy the same stock in a taxable account. Over the next 20 years, the stock pays no dividends, but it climbs 400%. The wife now has $10,000 in her Roth IRA, while the husband has $10,000 in his IRA and another $2,800 in a taxable account.
Both husband and wife empty their IRAs. She owes no taxes, so she pockets $10,000. Because the couple still pays taxes at 28%, he owes $2,800 on his $10,000 IRA withdrawal. As it happens, he has this sum in his taxable account.
All even? Not quite. When he sells the $2,800 of stock, he triggers taxes on the $2,240 of appreciation. If he pays capital-gains taxes at 20%, the sale will net $2,352. Result? After taxes, the husband has $448 less than his wife.
All this assumes constant tax rates. What if the 28% rate drops to 25%, as currently scheduled? And what if the husband takes advantage of the 18% capital-gain rate for investments held more than five years? The wife still wins, though her advantage shrinks to $103.20.
In truth, the wife will likely fare far better. The reason: Her husband probably wouldn’t invest the $560 from the initial tax deduction. “It’s unlikely in the real world that anybody will save the money,” argues Ed Slott, an accountant in Rockville Centre, N.Y.
Counting the Blessings
Still drawn to the IRA’s tax deduction? You may not even be eligible. If you are covered by your employer’s retirement plan, you can fully fund a tax-deductible IRA only if you are single with income below $33,000 or married filing jointly with income below $53,000.
Meanwhile, almost everybody is eligible for the Roth. As long as you are single with income below $95,000 or filing jointly with income below $150,000, you can fully fund a Roth. That could turn out to be a smart move, especially if you suddenly need a heap of cash.
Suppose you saved $2,000 every year for 10 years. If you were under age 59 1/2 and the money was in a regular IRA, you would get slapped with income taxes and probably a 10% penalty if you tried to touch the money.
But with a Roth, you could pull out your $20,000 of contributions before age 59 1/2 and pay nothing in taxes and penalties, provided you didn’t withdraw the account’s investment earnings. As Nicholas Kaster, a tax attorney with tax-law publisher CCH in Riverwoods, Ill., says, “The Roth involves much less commitment.”
Sound appealing? In the years ahead, you will be able to sock away even more. As with regular IRAs, the annual amount you can stash in a Roth is scheduled to increase, hitting $5,000 in 2008.
You could also convert your existing IRA to a Roth, presuming your annual income is below $100,000. True, you have to pay income taxes on the conversion. But if the tumbling stock market has slashed your account’s value, the tax bill involved will be much reduced.
In return for enriching Uncle Sam today, you will get greater flexibility down the road. As with regular Roth contributions, you can withdraw the amount converted before age 59 1/2. But once again, to avoid taxes and penalties, you can’t touch the account’s investment earnings until retirement. In addition, with a Roth conversion, to make a penalty-free withdrawal of the converted sum before age 59 1/2, you have to wait until five years after you converted.
The Roth’s greater flexibility continues into retirement. Roth IRAs aren’t bound by the minimum distribution requirements that kick in for IRA investors at age 70 1/2. That means you aren’t forced to empty your Roth and thus you could bequeath the entire account to your kids.
“In the case of the Roth, you can pass much more on to the heirs,” Mr. Kaster says. “There’s still an estate-tax bill there. But there’s no income tax owed.” Those who inherit regular IRAs aren’t so lucky. They still have to pay any income taxes due.
Pondering the Pitfalls
As attractive as the Roth sounds, there are three key pitfalls. First, Congress could decide to tax Roth withdrawals. This seems unlikely, but clearly it is a risk.
Second, if you believe your tax bracket will drop sharply once retired, you should stick with a tax-deductible IRA. In the above example, the husband would have accumulated $1,120.80 more than his wife if his IRA withdrawal was taxed at, say, 15% and his taxable account’s capital gain was dunned at 8%.
Finally, you shouldn’t convert your IRA to a Roth if you will have to dip into your IRA to pay the taxman, because that will trigger tax penalties if you are under age 59 1/2. “That’s a bad move,” Mr. Slott says. “You shouldn’t do it if you can’t afford the taxes.”
Write to Jonathan Clements at jonathan.clements@wsj.com
Updated September 9, 2001
I understand and appreciate the HD community’s focus on the IRMAA cliffs. But it’s important to actually look at the numbers involved (not just the fact of a change in surcharge) when making your decisions.
As I read the charts, a married couple will spend roughly an extra $1,600 on Medicare if their income exceeds $206K. at the next tier (income bet. $258K and $322K), the total surcharge is around $4,100. That’s nothing to sneeze at. But folks should know the actual amounts – and not simply take some action just to avoid IRMAA – when making their plans.
I agree. Too much focus on IRMAA by people with retirement incomes far above even the median working household income.
True.
IRMAA surcharges, while annoying, only last one year per conversion, and are minor compared to a 5-10% higher tax bracket (post 2025).
I agree. I have a very large IRA and chose not to convert because my income was too high when working. Now retired, my income is very low and nowhere near the IRMAA penalty amounts. My tax bracket is 10% or less now. Converting your IRA is NOT always the best way to go. My RMD requirements will not push me into IRMAA or a bracket close to what I would have had to pay if I did convert. My kids will inherit my IRA as well as taxable money, and even though they will pay taxes on it over the years, they can pay the taxes with the money they withdraw.
Last year we were in between doing a conversion or realizing some capital gains to make our portfolio simpler and more tax afficient, which I wrote about here: https://humbledollar.com/2023/12/running-up-the-tab/
We ultimately realized the CGs and did no conversion. If we took this route again this year, we could realize enough CGs at 15% to leave us with no actively managed funds in our taxable accounts.
It’s harder to tell if the math would favor this or a Roth conversion. We don’t have heirs so just a question of impact in our lifetimes.
At one point my wife’s employer started offering a Roth 401(k). We loaded that wagon.
We don’t have children and plan to leave our taxable IRAs to charitable institutions so there will be no tax due at that point.
I think we have an exceptional group here on HD. There is a lot of thought given to everyone’s various circumstances and obviously the group has been fortunate to accumulate some assets. I often wonder how the “uninterested” handle some of the complexities they encounter, or if they even realize what they are facing. My grandfather had a checkbook and savings account. Ah, the simple days.
Great article. I’m actually in the middle of looking at a potential Roth conversion for this low income year.
We could convert all of my wife’s IRA and eliminate an account, which would be nice, Mathematically it makes more sense to convert from mine, since I’m older, and thus RMDs will be required from mine first. (Thanks to Adam Grossman for pointing this out a while back.) As appealing as it would be to further simplify, if we do a conversion we’ll probably follow the math.
We are converting all of my wife’s IRA as her balance is significantly smaller than mine. as a result we will only have to take RMDs from my account, thus simplify our withdrawals. We will most likely live off of my traditional IRA RMDs/pension, and our delayed SS. If this comes to fruition, and she lives until at least 100 like her mother our children will benefit from at least 35 years of tax free returns in Vanguard World Stock ETF (VT). This plan should leave them quite a bundle!
For some reason I’ve been stopping at 22% instead of 24%. I don’t know why, given the likely increases of tax rates coming soon. You spur me on….
I’ve struggled over the same thing, partially because converting well into the 24% would also cause our other investment income to be subject to NIIT, increasing the tax on those by 3.8%. It muddies the math on how much to convert, at least for me.
I’ve been converting to my and my wife’s Roth’s for the past several years while also funding both my children’s Roth’s each year since they turned 21, despite taking the tax hit each year. I’m financially fortunate that I won’t deplete both accounts by the time I reach RMD age but I will keep enough in the traditional Roth’s to cover unforeseen medical expenses down the road and make charitable contributions. Thanks Jonathon for confirming this is a good decision I have made. This is why I read HD faithfully.
“Traditional Roths?” I like the sound of that–tax-deductible going in, tax-free coming out! Kinda like an HSA, only better. Seriously, this is exactly how we plan on using our HSA accounts–I like to think that we are pre-paying several years of Medicare Part B premiums now, so we can withdraw them tax-free later.
Unless, of Course, Congress changes the rules by the time we get there…
A very good strategy. We converted all of my wife’s Rollover IRA to her Roth, and now are working on mine, which is larger and will be reduced but not eliminated by YE 2025, as I am avoiding triggering quarterly IRS payments and IRMAA surcharges. Once I hit 70.5 I plan on pulling Qualified Charitable Contributions out of my Rollover IRA for contributions to our church and other charities to help reduce the balance further. They will still get some RMDs from me but not as much as they might prefer.
Anyone concerned about Congress deciding to tax Roth withdrawals? I can already hear them justifying it by saying the nation is in a financial crisis and they need our money more than we do. I sure hope this never happens.
I’m not particularly worried about Congress deciding to tax Roth withdrawals. While with Congress, anything *is* possible, what I see to be a more distinct future possibility is 1) changing the formula that determines how much SS is taxable to include Roth distributions, and/or 2)Higher marginal tax rates, especially the 24 per cent bracket and up. Item 2) would potentially argue in favor of more conversions now, while Item 1) would likely be a point against converting, for a lot of people.
If I am correct the income level to be subjected to 85% of your SS is so low I think the majority of those performing conversions will already be taxed on 85%. Do you mean they will include Roth income and change to 100% of SS being taxed?
I think it’s possible that Congress could simply change the MAGI formula that determines the amount of taxable SS to include Roth distributions. Since the formula already includes “tax free” Municipal bond interest as well as traditional IRA distributions, it wouldn’t be much of a stretch for Congress to try and slip in the inclusion of Roth distributions as well.
With the formula as it is now, a couple with a $1 million IRA, no pension,and $60k of SS benefits would only have around $30k of their SS included as taxable income once RMD’s start. So even with the relatively low threshold, this small change could impact quite a few people, and make Roth conversions a lot less attractive. Do I think it’s likely? Not any time soon, as Congress is on something of a “Roth honeymoon” right now, and wants to encourage the use of Roths as much as possible, as it’s a great short-term revenue producer. But as the number of Roth accounts increase, and as our nation’s fiscal condition grows ever more dire, I’d say such a change could easily be on the table. The future is a murky place, trying to predict these things 20 years in advance is tricky business at best.
One of the main lifetime mistakes I’ve made over the last 40 years is choosing to make tax-deductible retirement account contributions (using IRAs, SEP-IRAs, SIMPLE IRAs, 403b, and more recently Solo 401(k) accounts) instead of Roth contributions to either a Roth IRA or now a Roth 401(k), particularly in my earlier and lower income/lower marginal tax bracket years. Roths became available in 1998, so perhaps I only wasted ~26.5 years of those 40. My advice to my kids is “contribute to a Roth account whenever your marginal tax bracket is less than 24%.” I have no idea if that is technically accurate or not, but that rule would have certainly saved us some big upcoming tax bills when RMDs start for me in 2035.
I’m in the middle of my own quandary on doing a final conversion this year. Your run through of the advantages helps me get off the fence and make my decision. Thanks for your timely article. Humble Dollar is one of two “must read” sites for this 70 year old retiree (Bogleheads is the other.)
We did thi,s and now my wife’s ROTH is larger than her traditional IRA.