Roth Conversions: Buying Tax Certainty for the Future

For many retirees, the biggest financial risk isn't necessarily a market crash.

It may be the tax bill waiting for them 10 or 20 years down the road.

A retiree can spend decades doing exactly what they were told to do: contribute to their 401(k), fund their IRA, defer taxes and let the money compound. The result can be a very healthy retirement account.

But eventually, the IRS gets involved.

Traditional IRA and many retirement-plan assets are generally subject to required minimum distributions beginning at age 73. Those distributions are generally included in taxable income.

For a retiree with substantial tax-deferred assets, that can create an interesting problem.

You successfully accumulated wealth—but now you have to figure out how to get it out without creating an unnecessarily large tax bill.

The RMD Problem

Imagine a couple enters retirement with $2 million in traditional retirement accounts.

They don't necessarily need all of that money.

Social Security might cover a portion of their expenses. Perhaps they have a pension, taxable investments and other sources of income.

Meanwhile, their IRA continues growing.

Eventually, RMDs arrive.

Now the government is effectively telling them:

“You have to take money out of this account whether you need it or not.”

That money generally becomes taxable income.

And for a retiree who has accumulated significant assets, future RMDs can potentially push more income into higher tax brackets and create other downstream tax consequences.

This is why I believe Roth conversions deserve to be part of the conversation before RMDs begin, rather than after the problem has already arrived.

What Is a Roth Conversion?

A Roth conversion involves moving money from a traditional IRA or other eligible retirement account into a Roth IRA.

The important catch is that you're generally trading tax deferral today for tax-free treatment later, assuming the applicable Roth distribution requirements are satisfied.

The converted amount that represents untaxed traditional IRA assets is generally included in taxable income in the year of the conversion.

So a Roth conversion isn't magic.

You're paying the IRS.

The question is when you pay them, how much you pay them, and whether paying that tax today creates a better long-term outcome.

That's the heart of Roth conversion planning.