When Roth Conversions Actually Save Retirees Money (and When They Backfire), According to CFPs
Written by
Jordan Rosenfeld
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Molly Sullivan
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Roth conversions are often described as a smart move for retirees who want tax-free income later in life. But the same strategy that creates long-term savings for one household can trigger higher taxes, Medicare premiums or lost deductions for another.
Cristina Wiebelt-Smith, a CFP and wealth advisor with Gertsema Wealth Advisors, said, “With Roth conversions, the name of the game is cutting Uncle Sam out of the equation and keeping as much of your hard-earned money as possible.” Here are the circumstances when that works best.
When You Can Get a Lower Tax Rate Now
Roth conversions tend to work best when retirees can move money out of pretax accounts at a lower tax rate today than they expect to face in the future, Wiebelt-Smith said. This can include when future taxes are likely to rise due to required minimum distributions, portfolio growth or a surviving spouse filing as single. “By converting, retirees prepay the tax and allow all future growth to be tax-free,” she said.
However, Matt Hylland, a financial planner at Arnold and Mote Wealth Management, said that tax rates are only part of the equation. “While income tax rates are the primary driver, there can be other taxes to consider like the net investment income tax, Medicare IRMAA, taxes on capital gains and qualified dividends and taxes on Social Security.”
When You Can Stay Under Income Thresholds
Where Roth conversions often backfire is at income thresholds that cause sharp jumps in taxes. These “cliffs” could trigger a disproportionate increase in taxes or Medicare premiums with just a small increase in income.
Hylland explained the first cliff is just over $100,000 in taxable income for married households, where income above that threshold begins to be taxed at 22% instead of 12%.” Another major jump occurs above $403,000, when the marginal rate rises from 24% to 32%. “That 10% difference is a big jump,” he said.
Medicare IRMAA Changes the Roth Conversion Math
Beyond income taxes, retirees also need to watch for Medicare IRMAA thresholds when doing a Roth conversion. “Just going one dollar over those income thresholds will result in the entire IRMAA surcharge being applied,” Hylland said. “In a worst-case scenario, one dollar of income could cost a married couple more than $2,000 per year in added Medicare premiums.”
However, there is potentially a tradeoff as well, Hylland noted, in that it “may result in years or decades of savings down the road.”
The key, Wiebelt-Smith said, is weighing short-term pain against long-term benefit. “Tax planning can no longer be done in a vacuum. Every decision creates a ripple effect,” she said.
Partial and Multiyear Conversions
Advisors agreed that full conversions are rarely optimal. Partial conversions spread across multiple years give retirees more control over tax brackets, Medicare premiums and deductions.
Wiebelt-Smith emphasized timing. “Most retirees have enough in traditional IRAs that converting the entire account in one year would be prohibitively expensive,” she said. “By spreading Roth conversions over multiple years during lower-income windows, retirees can manage tax brackets, preserve deductions, limit Medicare premiums and reduce future RMDs.”
When Market Timing and RMD Planning Tip the Scales
Market conditions and future required minimum distributions (RMDs) can also determine whether a Roth conversion is a good idea, said Jennifer Kohlbacher, a CPA and director of wealth strategy at Mariner Wealth Advisors. “When markets decline, we often take advantage of the opportunity to convert IRA assets at temporarily reduced values.”
She described a recent case where timing during a market dip helped a client convert a large portion of their IRA and saved them more than $300,000 in income taxes.
Future RMDs are often the underlying driver. “RMDs are like a faucet you can’t turn off,” Wiebelt-Smith said. “Roth conversions help turn the pressure down so it’s manageable.”
In the end, Roth conversions save money not by avoiding taxes altogether, but by deciding which taxes retirees are willing to pay now to avoid larger ones later.
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