Summary/TL;DR
In the years leading up to retirement, contributing to one’s employer retirement plans on a pre-tax basis, investing tax savings into a brokerage account, and then using that brokerage account to pay taxes on conversions at lower rates in retirement is an exceptionally powerful strategy. Furthermore, the historically low tax rates provided by the Tax Cuts and Jobs Act as well as times of market distress present savers with additional opportunities for making tax-efficient Roth conversions. As always, the best way to ensure you are capitalizing on every opportunity available to you is to work with a team of competent and knowledgeable professionals.
Introduction
Today’s tax environment lends itself to a tremendous number of opportunities for many, and strategies such as Roth conversions are becoming better known by the general public. While they are absolutely a legitimate and very powerful tax planning tool, Roth conversions can be counterproductive if done without a broad range of tax knowledge.
Today’s post will focus on the high-level tax planning concepts relevant to Roth conversions, primarily centered on timing conversions for maximum efficiency.
Roth Conversion Basics
A Roth conversion is nothing more than a transfer of funds from a pre-tax retirement account to a Roth. The gross amount of the conversion is taxable in the year it is made, so great care must be taken to convert an appropriate amount. Once the funds are in the Roth, they will never be taxed again (assuming all other IRS rules are followed). Unlike Roth contributions, there are no income phaseouts or any other form of “limitations” placed on the amount of Roth conversions that one can make, meaning anybody with pre-tax retirement savings can make conversions with no limitations.
Due to the everchanging (and expanding) tax code, the way that income changes throughout one’s life, and the tax-free growth available in Roth IRAs, well-timed Roth conversions are one of the most powerful tax planning tools at one’s disposal. Hundreds of thousands of dollars in taxes can easily be saved with the right planning. Likewise, poorly timed Roth conversions might result in the opposite outcome with more taxes being paid because of the conversions than would have occurred without them.
When Is The “Right Time”
Whether or not Roth conversions should be made, let alone how much to convert, is a multivariate problem with an answer that differs for every person. The amount of pre-tax assets one has saved, their age, their spouses age, taxable income today and what it is expected to be later, the nature of their present and future income, whether or not social security has been claimed, and how many children one has are all considerations that affect the recommendations I give to clients on this issue. For today’s purposes, we’ll focus on the key consideration – what is one’s taxable income today, what is it expected to be in the future, and will making Roth conversions grant us opportunities to improve the situation?
One of my favorite strategies to pursue with clients is also one that effectively demonstrates the importance of these questions. It involves contributing to one’s employer retirement plans on a pre-tax basis, investing tax savings into a brokerage account, and then using that brokerage account to pay taxes on conversions at lower rates post-retirement.
Let’s take the example of a 60-year-old married individual with a $250,000 salary and an employer who offers a 401(k) with a 6% match. They want to retire when they are 65, leaving them with 5 years to continue saving towards their retirement. Because their salary puts them in a “higher” tax bracket today, we contribute to their 401(k) on a pre-tax basis and use the amount they’ve saved in taxes to save into a non-qualified brokerage account. When they retire, we convert $40,000 of their 401(k) to Roth every year and use their non-qualified account to pay taxes on the conversions, which are presumably taxed at a lower rate. After they begin social security at age 67, we convert $60,000 every year. Assuming the accounts grow at an average of 8% annually along the way, this individual will have a Roth IRA balance of about $275,000 and still have saved about $8,000 in taxes from their initial contributions to their 401(k)!
This is a great example of how the different types of retirement accounts can be used in conjunction with one another to create an immensely beneficial tax plan. And this is a very oversimplified example. With proper planning, you can make tax-free Roth conversions throughout retirement! An example of how this could work is shown below.
Here, I’ve assumed a married couple (with both spouses over the age of 65) has the following income sources: $10,000 in Traditional IRA distributions, $63,000 in social security benefits, and $20,000 in distributions from a taxable brokerage account (25% of which are attributable to long-term capital gains). Because of the nature of this income and the level of their deductions, their taxable income is negative!
Every good tax planner knows, however, that negative taxable income is generally not a desirable outcome. You don’t get money back on your tax return for having negative taxable income, so you might as well realize enough income to make your taxable income $0 (or slightly positive), and Roth conversions are an exceptional tool for achieving this. In the example above, this couple could make a $7,650 Roth conversion and still pay $0 in taxes!
Other Roth Conversion Opportunities
Before we wrap up today’s post, I want to discuss a couple of additional circumstances which present great opportunities to make Roth conversions, one of which is temporary and likely to end soon, and another that will always be around.
The Tax Cuts and Jobs Act
The lowest hanging fruit with Roth conversions are the low tax brackets currently in place as a result of the Tax Cuts and Jobs Act. In 2026, these brackets are currently scheduled to revert to their pre-2017 levels which, as can be seen below, are generally higher.
I’ve drawn a box around what is now the 24/32% brackets and what will become the 28/33% brackets for married couples, as the income ranges for these brackets change in a very unfavorable way as well. Many who are still working that are currently in the 24% bracket might find themselves within the 33% bracket unless the current legislation gets extended.
Bear Markets and Market Corrections
Another great opportunity to make Roth conversions is during market downturns, as you are essentially paying taxes on “discounted” valuations only to recover all growth tax-free during the inevitable recovery.
Working With A Professional
As always, working with a competent and knowledgeable professional is key to capitalizing on the tax planning opportunities presented by Roth conversions. For most, a financial planner and CPA working together will make a great team.
The value and benefit of working with these professionals will far exceed their cost in the long run, and will also ensure that you capitalize on other opportunities not covered here.
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