FREE NEWSLETTER
EVERY ARTICLE ABOUT Roth conversions says the same thing: pay the tax from taxable money, not from the IRA.
That is good advice if you have taxable money.
Plenty of retirees do not. Their savings sit almost entirely in a traditional IRA, built from years of 401(k) contributions and a rollover at retirement, with little brokerage money and no cash reserve worth naming.
For them, “pay from outside money” is not advice. It is a condition they do not meet. Their real choice is a self-funded conversion or no conversion at all.
The familiar warning is that self-funding requires a gross-up. You withdraw money to pay the conversion tax, that withdrawal is itself taxable, so you have to withdraw a little more.
Less discussed is what else that withdrawal sets off. It makes more of your Social Security taxable, it raises your Medicare premiums two years later, and in a high-tax state it enlarges the amount that has to leave the IRA. Here is what those three cost, on one household.
A cautious conversion
Meet Dianne, a composite rather than a real person. She is 66, single, retired to Florida, with $1 million in a traditional IRA and nothing outside it. Social Security pays her $28,000 a year.
She is past 59 and a half and already on Medicare. Florida keeps state income tax out of the arithmetic for now.
She converts $40,000. Careful, modest, the size people choose when they are trying not to do anything dramatic.
The tax on that conversion, paid from a checking account she does not have, would be $4,234. Funding it from the IRA instead, the withdrawal that covers it is $5,125, and her tax rises to match.
That extra $891 is 17.4% of the $5,125 she withdrew. Her ordinary-income bracket is 12%.
Twelve of those points are the tax on the withdrawal itself, which is the gross-up everybody expects. The other 5.4 points come from $2,300 of her Social Security being pulled into taxable income by that same withdrawal.
Paying from cash, $21,500 of her benefit would be taxable. Self-funding, $23,800 is. The difference is caused by how she paid, not by what she converted, and nothing on her return will label it.
Not a smaller version of a large one
The effect is not linear. Run the same woman at $150,000 and 85% of her benefit, the statutory maximum, is already taxable before she funds the tax. The funding withdrawal drags in nothing further, and this particular cost is zero.
That is not an argument for converting more. It is an argument against assuming a small conversion is simply a smaller version of a large one. The one that looks cautious can carry the higher marginal rate.
What self-funding actually costs
Give Dianne the $150,000 conversion, still with no outside cash, and add the state question.
Still in Florida, $195,469 has to leave the traditional IRA to put $150,000 into the Roth. Move her to California, changing nothing else, and it is $219,751. That is $1.30 of IRA spent for every dollar reaching the Roth, against $1.47, and the gap is California income tax compounded through the gross-up. If a move across state lines is anywhere in your plan, the order of operations may matter more than the size of the conversion.
But $1.47 invites a conclusion it does not support, and I would rather correct that myself than let it travel. A conversion is taxable whichever pocket pays.
Of the $69,751 Dianne withdraws in California, roughly $44,639 replaces cash she would have spent anyway. The incremental cost of self-funding, in wealth given up, is $25,111. About 17% of the conversion, not 47.
The bill that arrives in 2028
At that $150,000 conversion, self-funding also costs Dianne $1,735 in higher Medicare premiums, a surcharge of $6,355 rather than $4,620, charged on top of the standard premium, for one year, and hers alone as a single filer.
The bill arrives two years late. Medicare sets her 2028 premiums from her 2026 income, so the cost is invisible at the moment she is deciding how to pay the 2026 tax.
When it can still make sense
Doing nothing is not free either. Money left in a traditional IRA comes out eventually, under required distributions, at whatever rates apply then, possibly to a survivor filing single, possibly to heirs facing a 10-year deadline.
Where self-funding still holds up, a few things tend to be true.
The rate gap is durable rather than a one-year accident. Whether it repays a cost this size depends on time, future tax rates and investment returns. A temporary dip in income is a thin foundation. A structural window, after retirement and before Social Security or required distributions begin, is more compelling.
There is runway, because shrinking the portfolio to change its tax character needs years of tax-free growth to earn back.
Age 59 and a half is cleanly behind you. The converted amount is not subject to the 10% additional tax on early distributions. A separate distribution taken to pay the tax generally is, unless an exception applies.
And enough is left afterward. Check the balance after the funding withdrawal, not after the conversion. Dianne’s California IRA drops to $780,249, and whether that funds the next 30 years matters more than whether the conversion was tax-efficient.
A practical warning about withholding
Withholding from the conversion is not a cheaper way to pay the tax. It reduces what reaches the Roth.
Elect 24% on Dianne’s $40,000 conversion, as this illustration does rather than as any custodian requires, and $9,600 goes to the IRS while $30,400 lands in the Roth, against $4,234 actually owed. The cash comes back next spring as a refund. The Roth room does not come back at all.
Restating the rule
Pay the conversion tax from outside cash if you have it. That remains the best answer.
It is not an answer for the retiree whose savings are almost entirely in a traditional IRA. For that person, “never pay from the IRA” skips the actual decision, which is whether a self-funded conversion, with its full marginal cost, beats leaving the money where it is.
Before deciding, count the gross-up, the Social Security effect, state tax and the Medicare bill two years later. Sometimes that arithmetic still says no. It beats applying a rule written for somebody with a different balance sheet.
________________________________________________________________________________
John Urban is the founder of RetireSmartIRA, a retirement tax-planning app. Earlier, he founded GT Nexus, a supply-chain software company acquired by Infor in 2015. He lives in Northern California with his wife, Kathy, and enjoys time with family, travel, reading, Bay Area sports, and the occasional deep dive into the fine print of the tax code.
Another important cost of Roth conversions that is rarely addressed is the opportunity cost of the money used to pay the conversion tax.
If someone had $50,000 of taxable money available to pay the tax, that $50,000 isn’t just “spent” — it’s $50,000 that can no longer remain invested and compound. The comparison shouldn’t only be today’s tax cost versus the potential future tax savings. It should also consider what that tax money could have grown to, on an after-tax basis, if it had remained invested.
I’d be interested in seeing a Roth-conversion analysis that includes the opportunity cost of the tax payment itself, along with the future tax savings.
I recently read a book called The Roth Conversion Formula by Alex O’Shea. The book provides 10 case studies using 2026 tax law. It was an easy and understandable read.
Has anyone experimented with the author’s RetireSmartIRA and compared it to other programs? I went to the website and it looks interesting. As with any source, how do you know the information is accurate in the details it returns?
I enjoyed the author’s article, although nebulous in some parts and will require reading several times over. His other articles have also been good to read.
Olin, that is a fair question. I have an obvious interest in the specific answer, so let me answer the general one.
I would not trust any planning tool just because it produces a detailed number. The important question is whether you can see enough of the work to understand what drove that number.
For me, there are a few things worth looking for:
I have not read the O’Shea book, so I cannot offer a comparison. But those are the standards I would use for any retirement-planning tool.
And thank you for the “nebulous.” I know my writing can get dense when I am deep in a topic. I will try to do better.
Best regards,
John
I believe the reasoning is thorough, and the article brings out various aspects involved in the consideration of conversion. It also illustrates that results vary depending upon “starting conditions.” I did not check each number and don’t think that is necessary.
I also checked out the Boldin site suggested below. Once again, and as expected, results vary depending upon how you set it up.
I would start with a simpler analysis tailored to a limited problem statement with fewer variables. That gives a better handle on the impact of each variable and project tax consequence.
Great analysis but, as I think has been pointed out somewhere previously, let’s not forget about the survivor’s tax penalty and the downstream tax advantages for heirs that also come into play beyond just one’s current tax situation for MFJ esp w children.
Mark, you are right to raise both. The article prices what self-funding costs and stops there, and the two things you name sit on the other side of that ledger.
On the survivor penalty I wrote a piece here in July, and the part worth knowing is that it hits middle-income couples hardest, not affluent ones. On heirs, the reason children matter is timing: under the 10-year rule an inherited traditional IRA usually comes out during their peak earning years, so the rate that applies is theirs, not yours.
Thanks for your comment,
John
John, thanks for an interesting article. The tax interactions are complex and challenging for many of us. I wondered how Dianne’s modest conversion might impact the $6,000 additional senior deduction. Using Dinkytown’s 1040 calculator I found that she could increase her IRA withdrawal to $51,200 and still get the full $6,000 deduction. At that point her taxable income is $400 over the limit for the 12% bracket (into the 22% bracket). So a $50,000 IRA withdrawal would keep her in the 12% bracket, remain eligible for the senior deduction, avoid 2028 IRMAA, and cause a total tax bill of $5,713, leaving $44.287 to convert to her Roth.
One final thought that s beyond the scope of this article. This leaves her $28,000 to live on – equal to her total pre-tax SS benefits. I think Dianne would be a good candidate for a comprehensive retirement analysis, including understanding her situation and goals for retirement and legacy bequests. The Roth conversion might make sense, but it is not obvious without further information and analysis.
Rick, thank you. I ran your numbers through the same projection engine I used for the article, and they hold up.
A $44,287 conversion, funded from the IRA, requires about $5,710 more from the IRA to pay the tax. Total IRA outflow is essentially $50,000, just as you calculated.
The $51,200 number is worth noting. Both the conversion and the withdrawal used to pay its tax count as ordinary income. The number to watch is total IRA dollars leaving the account, not just the conversion amount. At $51,200 of IRA outflow plus $23,800 of taxable Social Security, Dianne lands at the $75,000 threshold for the full senior deduction. Past that point the $6,000 falls six cents for every dollar of income, so a dollar over the line is taxed as $1.06, which turns her 12% into roughly 12.7%.
At $50,000 she stays inside the 12% bracket, and IRMAA is not in play at any of these levels.
Your larger point is equally important. I gave Dianne no spending needs so the article would focus attention on the mechanics of a self-funded conversion. That makes the tax effect easier to see, but it does not tell us whether she should convert. A 66-year-old living on $28,000 of Social Security while taking roughly $50,000 from her IRA needs the broader retirement analysis you describe: spending, longevity, portfolio risk, future RMDs, and any legacy goal.
The conversion might still make sense. But it is certainly not obvious from the tax calculation alone, especially when a Roth contribution during working years may have avoided the self-funding issue in the first place.
John
John, I love your posts. Thanks for illustrating the importance of doing a comprehensive look at the math before jumping into conversion mania. It would be interesting to analyze the effects of funding Roth accounts during one’s working years, versus doing conversions after age 59.5. I suspect some would have been better off doing the former.
Dan, thank you. I think you’re right, and for one group I would put it more strongly than “suspect.”
A Roth contribution while you are working pays its tax from your paycheck, which is outside money by definition. No gross-up. No additional Social Security taxation. No Medicare surcharge two years later. The mechanism in the article never starts.
Whether that beats converting later still turns on the rate you paid, the years left to compound, whether a low-income window opens between retirement and required distributions, and one point that gets ignored: whether the tax savings from the traditional contribution were actually saved rather than spent.
I wrote about the post-59½ case because I received emails from people who knew the pay-from-taxable-money rule but had no taxable money to follow it. They wanted to know what it costs to do it anyway. That was the gap I wanted to close.
But your version of the question deserves its own piece as well.
Thanks as always for adding to the conversation!
John
Bolden has an excellent projection tool for analyzing ROTH conversions. One feature that helped us decide not to convert was the time factor, which I feel Bolden handled quite well. Bob Berger is also a fan of Bolden, for what it’s worth.
https://www.boldin.com/
Excellent article.
Thank you, John
Thank you Gary!