Planning for retirement isn't only about building wealth—it is also about understanding how your retirement assets may be taxed during your lifetime and how they may ultimately be transferred to your beneficiaries.
One planning strategy that may be appropriate for some investors is a Roth conversion. While Roth conversions can create valuable planning opportunities in certain circumstances, they are not appropriate for everyone. The decision to convert assets from a Traditional IRA to a Roth IRA should be evaluated in the context of your complete financial picture and in coordination with your CPA or qualified tax professional.
At Shepherd's Way Financial, we believe that retirement planning is most effective when investment planning, tax planning, and legacy planning work together.
Key Takeaways
A Roth conversion allows assets to move from a Traditional IRA to a Roth IRA and generally creates taxable income in the year of conversion.
Some investors evaluate converting only enough assets to remain within a desired federal income tax bracket rather than converting an entire account at once.
Roth conversions may influence future Required Minimum Distributions (RMDs), retirement income planning, and legacy planning.
The SECURE Act changed the rules governing many inherited IRAs, making beneficiary planning more important than ever.
Every Roth conversion should be evaluated with your financial advisor and coordinated with your CPA or qualified tax professional.
What Is a Roth Conversion?
A Roth conversion is the process of transferring assets from a Traditional IRA into a Roth IRA.
The amount converted is generally included as taxable ordinary income during the year of the conversion. Once the assets are in the Roth IRA, future qualified withdrawals may be income tax-free under current law if applicable requirements are satisfied.
Because the tax consequences occur immediately while many potential benefits may occur years later, determining whether a Roth conversion makes sense requires careful planning.
Why Roth Conversion Planning Has Become More Important
Several changes have increased interest in Roth conversion strategies, including:
Larger retirement account balances
Longer retirement time horizons
Required Minimum Distribution (RMD) rules
Changes made by the SECURE Act affecting inherited retirement accounts
Uncertainty regarding future tax laws
These factors do not automatically make Roth conversions beneficial, but they do make retirement tax planning an increasingly important part of an overall financial strategy.
Understanding the "Fill the Tax Bracket" Strategy
One approach sometimes evaluated is informally referred to as "filling the tax bracket."
Instead of converting an entire Traditional IRA in one year—which could move an investor into a significantly higher marginal tax bracket—some individuals evaluate converting only enough assets to remain within a targeted tax bracket.
Illustrative Example
Assume a married couple has:
$150,000 of taxable income after deductions
A Traditional IRA valued at $900,000
Additional room before reaching the top of the 22% federal income tax bracket
Working together with their financial advisor and CPA, they may evaluate converting only the amount that allows them to remain within the 22% bracket rather than converting substantially more and increasing their current year's tax liability.
This illustration is provided solely for educational purposes. It is not intended as a recommendation, and the appropriate conversion amount—if any—depends on many factors, including current and anticipated tax rates, available cash to pay conversion taxes, Medicare premium considerations, retirement income needs, estate planning goals, and applicable state income taxes.
How Roth Conversions May Affect Required Minimum Distributions
Traditional IRAs are generally subject to Required Minimum Distributions beginning at the applicable age under current law.
Those distributions may:
Increase taxable income
Influence the taxation of Social Security benefits
Affect Medicare Income-Related Monthly Adjustment Amounts (IRMAA)
Reduce flexibility when managing retirement income
Assets converted to a Roth IRA are generally no longer subject to lifetime RMDs for the original account owner under current law.
For some individuals, this may provide additional flexibility when coordinating retirement income with broader tax planning objectives. However, reducing future RMDs should always be weighed against the current tax cost associated with a Roth conversion.
Roth IRAs and Leaving a Legacy
Many families are equally concerned about how retirement assets will affect the next generation.
The SECURE Act significantly changed how many inherited retirement accounts are distributed.
For most non-spouse beneficiaries, inherited IRAs generally must be distributed within ten years following the account owner's death.
This is commonly referred to as the 10-Year Rule.
Inheriting a Traditional IRA
Distributions from an inherited Traditional IRA are generally taxable as ordinary income.
If beneficiaries receive those distributions during their highest earning years, those withdrawals may increase their taxable income.
Inheriting a Roth IRA
Inherited Roth IRAs are generally also subject to the 10-Year Rule.
However, qualified distributions are generally income tax-free under current law.
For some families, this difference may become an important consideration when evaluating long-term legacy planning objectives.
Whether a Roth conversion improves the outcome depends upon numerous factors unique to each family's financial circumstances.
Traditional IRA vs. Roth IRA
| Consideration | Traditional IRA | Roth IRA |
|---|---|---|
| Contributions | May be tax-deductible if eligible | Not tax-deductible |
| Taxation During Distribution | Generally taxable | Qualified distributions generally tax-free |
| Lifetime RMDs | Generally required | Generally not required for original owner |
| Inherited Account | Generally taxable to beneficiary | Qualified distributions generally tax-free |
| Subject to 10-Year Rule | Generally yes | Generally yes for most non-spouse beneficiaries |
Questions to Discuss With Your CPA Before Considering a Roth Conversion
Every investor's situation is different. Before implementing any Roth conversion strategy, consider discussing questions such as:
What federal tax bracket am I currently in?
What tax bracket do I expect during retirement?
How much additional taxable income can I recognize this year?
How will a conversion affect my Medicare premiums?
Could a conversion affect the taxation of my Social Security benefits?
Do I have funds available outside my IRA to pay the conversion taxes?
How might a Roth conversion affect my estate planning objectives?
Does this strategy complement my overall retirement income plan?
These conversations are best had with your CPA or qualified tax professional working alongside your financial advisor.
Frequently Asked Questions
Is a Roth conversion taxable?
Generally, yes. The amount converted is typically included as ordinary income during the year of the conversion.
Can I convert only part of my Traditional IRA?
Yes. Partial Roth conversions are permitted and are often evaluated as part of broader retirement tax planning.
Does a Roth IRA have Required Minimum Distributions?
Under current law, Roth IRAs generally are not subject to lifetime RMDs for the original account owner.
Do inherited Roth IRAs still have the 10-Year Rule?
In many cases, yes. Most non-spouse beneficiaries remain subject to the SECURE Act's 10-Year Rule, although qualified distributions are generally income tax-free.
Should everyone complete a Roth conversion?
No. Roth conversions are not appropriate for every investor. The decision depends on each individual's tax situation, retirement goals, cash flow, estate planning objectives, and many other factors.
Is a Roth Conversion Worth Exploring?
A Roth conversion is not simply an investment decision—it is also a tax planning decision.
For some investors, converting assets to a Roth IRA may complement their retirement income strategy and legacy planning goals. For others, the immediate tax consequences may outweigh the potential long-term advantages.
The appropriate approach depends on your unique financial circumstances and should always be evaluated in coordination with your CPA or qualified tax professional.
At Shepherd's Way Financial, we believe that thoughtful planning begins with understanding your goals before recommending strategies. We are committed to working collaboratively with your CPA and other professional advisors to help evaluate retirement income, tax planning, and legacy planning opportunities that align with your overall financial plan.
If you would like to discuss whether a Roth conversion should be evaluated as part of your retirement strategy, we invite you to schedule a conversation. Together with your tax professional, we can help determine whether additional analysis is appropriate for your situation.
Disclosure: This article is provided for educational and informational purposes only and should not be construed as individualized investment, tax, or legal advice. Roth conversions involve tax consequences and may not be appropriate for every investor. The tax treatment of a Roth conversion depends on individual circumstances and current law, which may change. Before implementing any strategy discussed in this article, consult with your CPA or qualified tax professional. Securities and advisory services offered through LPL Financial, a Registered Investment Advisor, Member FINRA/SIPC.