When Does a Roth Conversion Make Sense?

Retiring from Savannah River Nuclear Solutions (SRNS) or another Augusta-area job often brings an odd tax year. The paychecks stop, but Social Security and required withdrawals haven’t started yet. Taxes don’t stop when work does, either. About 40% of people who get Social Security pay income tax on their benefits.¹

A Roth conversion lets you choose the year you pay tax on some of your retirement money. It can help in some years and hurt in others, so the goal is to know which kind of year you’re in. If you want the basics of Roth accounts first, start with our guide to how 401(k) and Roth decisions fit together.

What Are You Trading When You Convert to a Roth?

A Roth conversion moves money from a pre-tax account, like a traditional IRA or 401(k), into a Roth account. You pay income tax this year on the amount you move. In return, qualified withdrawals from the Roth may come out tax-free later.

There’s one catch that raises the stakes. Since 2018, you can’t undo a conversion once it’s done.² Moving money between accounts sounds harmless, but this move comes with a tax bill you can’t take back, so timing matters a lot.

When Does a Roth Conversion Make Sense?

A Roth conversion may make sense when your tax rate this year is likely lower than it will be when you take the money out later, and you can pay the tax without pulling it from the retirement account. It often fits best in years when your income dips for a while.

Your Tax Rate Today May Be Lower Than It Is Later

U.S. income tax works in brackets. Each new chunk of income is taxed at the rate of the bracket it lands in.³ If your income is low this year, the money you convert may fill up the lower brackets. If your income is high, the same conversion costs more. Our article on moving up a tax bracket shows how this works.

Then think about what your income may look like later. A pension, Social Security and large pre-tax balances can keep your income higher in retirement than many people expect. Nobody knows what tax laws will look like years from now, so treat this as an estimate rather than a sure thing.

The Gap Years Between Retirement and Required Withdrawals

For many people, the main window comes after work ends and before Social Security and required withdrawals begin. Your income in those years may be lower than at any point in your working life. If you’re retiring from SRNS, a pension that starts right away can shrink that window. It helps to map out when each income source begins, and our page on retirement planning for SRNS employees explains how those pieces fit together.

A Short Dip in Income

You don’t have to be retired to have a low-income year. A job change, time off between jobs or a move to part-time work can all lower your income for a year. In this hypothetical example, for illustration only, say you usually earn $100,000, but a job change drops your income to $40,000 for one year. A $20,000 conversion that year stacks on top of a much smaller income, so more of it may land in a lower bracket. This example leaves out growth, inflation and other taxes.

You Can Pay the Tax With Cash

Paying the tax with money from savings lets the full amount move into the Roth. If the tax comes out of the account itself, less money ends up in the Roth, and the trade looks a lot less appealing. Having cash set aside before you convert can make a big difference.

You Want Choices About Where to Pull Money From

Having money in both pre-tax and Roth accounts gives you options later. In a year with a large expense, you could pull from the Roth without adding to your taxable income. That flexibility costs tax now, though, so weigh it against what you’d pay today.

How Required Minimum Distributions Change the Math

Required minimum distributions (RMDs) are withdrawals the IRS makes you take from most pre-tax accounts each year. They generally start the year you turn 73. Roth IRAs and Roth 401(k)s don’t require them while the original owner is alive, though people who inherit a Roth still have withdrawal rules.⁴

Large pre-tax balances can mean large RMDs. Those withdrawals add to your taxable income whether you need the money or not. Converting some money before RMDs start may shrink those future withdrawals.

Once RMDs begin, the order of steps matters. You can’t convert the amount you’re required to take for the year, so that withdrawal has to come out first.⁵ You can still convert after RMD age, but each conversion then stacks on top of income you can’t avoid.

When a Roth Conversion May Not Make Sense

A conversion can cost more than it saves. These are the situations where holding off may be the better call:

A big jump in your tax bracket: A large conversion can push part of your income into a much higher bracket. At that point, the tax you pay now may be more than what you’d likely pay later.

Higher Medicare premiums later: Medicare uses your tax return from two years ago to decide whether you owe an extra charge, called the Income-Related Monthly Adjustment Amount (IRMAA).⁶ That means a conversion at 63 could raise your premiums at 65.

More of your Social Security getting taxed: If you already get Social Security, extra income can make more of your benefit taxable. Up to 85% of your benefits can be taxed once your combined income passes certain levels.⁷

Needing the money soon: The tax you pay up front needs years of tax-free growth to pay off. Roth accounts also have five-year waiting periods that can affect when withdrawals are tax-free.⁸ Our guide to the Roth five-year rules explains how they work.

Expecting a lower tax rate later: If your income will likely drop a lot in retirement, paying tax now may cost more than waiting. State taxes play a part too, and Georgia’s rules for retirement income can change the math for local retirees.

How Your Spouse and Heirs Change the Decision

Married couples who file jointly get wider tax brackets than single filers. After one spouse dies, the survivor usually files as single, so the same income may be taxed at higher rates. Converting while you’re both alive may lower the pre-tax balance a surviving spouse has to draw from later.

Your heirs matter too. Most children and other non-spouse heirs who inherit a retirement account have to empty it within a set number of years. Withdrawals from an inherited Roth are generally tax-free, but that doesn’t make a conversion right for every family. If your heirs will likely be in a lower bracket than you, leaving the money pre-tax may cost less overall. Our guide to what taxes you’ll owe on a Roth conversion walks through both situations.

Why One Year’s Tax Bracket Isn’t Enough to Decide

Whether this year is a good conversion year also depends on the years around it. A projection that looks five or ten years ahead can show when your pension starts, when you plan to claim Social Security, when RMDs begin and which years Medicare will look back on. That makes it easier to spot the low-income years worth using.

Timing inside the year matters as well. A conversion counts in the calendar year you make it, so it has to be done by December 31 to count for that year. Many people decide near year end, once they know most of their income, which is the idea behind our end-of-year tax planning guide.

Your situation can change from year to year. A new job, a market drop or a change in health can change how much it makes sense to convert, if anything. Reviewing it each year with your tax preparer keeps the plan current, and our tax and estate planning work is built around that kind of teamwork.

Roth Conversion Timing FAQs

1. Do You Have to Convert Your Whole IRA at Once?

You can convert part of an IRA and leave the rest where it is. Many people convert smaller amounts over several years so each conversion fits the room left in that year’s tax bracket.

2. Can You Do a Roth Conversion Inside Your 401(k)?

Sometimes. Some workplace plans allow in-plan Roth conversions, and others don’t. Your plan documents or plan administrator can tell you whether yours does. Converting an old 401(k) after you leave a job is a separate decision with its own trade-offs.

3. What Happens if the Market Drops Right After You Convert?

You still owe tax on the value you converted, even if the account drops afterward. Since a conversion can’t be undone, you can’t redo it at the lower value. The money in the Roth may recover over time, but there’s no promise it will.

Deciding Whether a Roth Conversion Fits Your Retirement Plan

At AP Wealth, we look at Roth conversions as one part of your whole retirement picture, including your pension, Social Security timing, RMDs and Medicare. We can map out several years of taxes, show how different conversion amounts might play out and work with your tax preparer before any money moves.

If you’re wondering whether this year could be a conversion year for you, schedule a complimentary consultation with our team.

Resources:

1. Retirement Benefits
2. Retirement Plans FAQs Regarding IRAs
3. Federal Income Tax Rates and Brackets
4. Retirement Topics: Required Minimum Distributions (RMDs)
5. Publication 590-A, Contributions to Individual Retirement Arrangements (IRAs)
6. Medicare & You
7. Must I Pay Taxes on Social Security Benefits?
8. Instructions for Form 8606

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