ROTH CONVERSION PLANNING
The Biggest Cost of a Roth Conversion May Be Not Doing One.
Everyone talks about the tax you pay to convert. But what could it cost you if you don't?
A Roth conversion creates an immediate and visible tax bill. That's why many people stop the conversation right there.
But leaving money in a tax-deferred IRA, 401(k), 403(b), 457 or TSP may also have long-term tax consequences as the account grows, withdrawals begin, required distributions eventually apply, and retirement assets are ultimately transferred to heirs.
The conversion tax is easy to see. The cost of NOT converting is easier to miss.
The first question isn't “Should I convert?” It's “Which path makes more mathematical sense for my retirement?”
TWO DECISIONS. TWO VERY DIFFERENT TAX PATHS.
Don't Compare a Roth Conversion to Doing Nothing. Compare the Potential Cost of Both Decisions.
PATH 1
KEEP IT TAX-DEFERRED
What could staying tax-deferred ultimately cost?
- Continued tax-deferred account growth
- Future taxable withdrawals
- Required minimum distributions when applicable
- Potential effects on taxable retirement income
- Potential Medicare IRMAA considerations
- Potential Social Security tax interactions
- Taxes ultimately paid when assets are withdrawn
- Tax considerations for beneficiaries who inherit tax-deferred accounts
PATH 2
CONVERT TO ROTH
What could paying the tax today potentially provide in return?
- An immediate conversion-tax cost
- Potential future tax-free growth
- Qualified tax-free withdrawals
- No lifetime required minimum distributions for the original Roth IRA owner
- Greater potential control over taxable retirement income
- Potential legacy and estate-planning advantages
- Greater tax diversification in retirement
Note: Roth tax treatment depends on applicable IRS requirements and individual circumstances.
This Is a Math Problem Before It's a Roth Conversion Strategy.
The goal isn't to convert simply because Roth accounts sound attractive. The goal is to compare the projected long-term cost of remaining tax-deferred with the cost and potential benefits of converting.
COST OF CONVERTING TODAY VS. POTENTIAL LIFETIME COST OF REMAINING TAX-DEFERRED
If the numbers don't support converting, that matters. But if the mathematics indicates that a conversion may improve the long-term retirement picture, another important question becomes worth asking.
AND THEN THE CONVERSATION GETS INTERESTING.
What If the Cost of Converting Could Potentially Be Reduced?
Once the numbers indicate that a Roth conversion may make financial sense, the next step is determining how to execute the conversion as efficiently as possible. Depending on the individual's circumstances, advanced tax-planning strategies may be available to help reduce, offset or potentially recapture portions of the conversion-tax cost.
First determine whether converting makes mathematical sense. Then explore whether the cost of converting can be improved.
What a Roth Conversion Actually Does
A Roth conversion is the process of moving funds from a traditional, tax-deferred retirement account into a Roth account, choosing to pay income taxes on that amount now rather than later.
Tax-Deferred Account
→
Pay Applicable Income Tax Today
→
Roth Account
Qualified Roth IRA distributions can potentially be received income-tax-free when applicable requirements are satisfied.
THE PART OF ROTH CONVERSION PLANNING MOST PEOPLE MISS
What If the Conversion Tax Could Be Managed More Strategically?
Most Roth conversion conversations focus on one question: "How much tax will I owe if I convert?"
But there may be another question worth asking: "What legitimate planning strategies may be available to help reduce, offset, or potentially recover some of the tax cost?"
Depending on your financial, business, investment and tax situation, there may be planning opportunities worth evaluating alongside a Roth conversion. These strategies are not appropriate for everyone, and they should be coordinated with qualified tax and legal professionals.
The goal isn't simply to convert more money. It's to keep more of what you've built.
Three Ways to Think About the Conversion Tax
REDUCE
Reduce the Tax Impact
Explore legitimate planning strategies that may reduce taxable income or improve the overall tax efficiency of a Roth conversion.
OFFSET
Offset Conversion Income
Evaluate available deductions, credits, charitable strategies, business or investment-related tax benefits and other planning opportunities that may help offset taxable conversion income when legitimately applicable.
RECAPTURE
Potentially Recover Part of the Cost
Certain planning strategies may create opportunities to potentially recapture or recover portions of taxes paid over time, depending on the taxpayer's complete financial situation.
Reduce. Offset. Recapture. The appropriate strategy depends on your individual tax picture.
ADVANCED ROTH CONVERSION PLANNING
The Tax Bill Doesn't Have to Be the End of the Conversation.
A Roth conversion intentionally creates taxable income today in exchange for potential future benefits. Because of this, the surrounding tax strategy is extremely important.
- Multi-year Roth conversion planning
- Existing deductions and tax attributes
- Conversion timing and tax-bracket management
- Business-owner tax strategies
- Loss and deduction planning where legitimately available
- Real-estate and investment-related tax considerations
- Charitable planning when appropriate
- Coordination with a client's CPA, tax professional and attorney
- Strategies designed to potentially recapture portions of tax costs
These strategies can be complex. The objective is not to create a tax scheme—it is to identify legitimate planning opportunities that fit the client's actual financial situation.
Before You Accept the Roth Conversion Tax Bill, Let's Look at the Whole Picture.
Two people can convert the same amount of money and have very different planning opportunities.
Income, business ownership, investments, charitable goals, deductions, retirement timing and other factors can materially change the conversation.
This is where personalized Roth conversion planning begins.
1. ANALYZE
"Review your retirement accounts, income and tax picture."
2. MODEL
"Compare different conversion amounts and timing strategies."
3. IDENTIFY
"Look for legitimate tax-reduction, offset and recapture opportunities."
4. COORDINATE
"Work alongside your CPA, attorney or other tax professionals when appropriate."
Don't Just Ask Whether You Should Convert.
Ask How the Conversion Can Be Structured More Efficiently.
Before moving a significant portion of your retirement savings, let's evaluate the conversion itself, the tax it may create, and the planning strategies that could potentially change the overall economics of the decision.
Tax strategies vary based on individual circumstances. Marcel Mariano Retirement does not provide legal or tax advice. Tax and legal matters should be reviewed with qualified tax and legal professionals.
RETIREMENT YEARS BEFORE REQUIRED MINIMUM DISTRIBUTIONS BEGIN
The period between retirement and the start of RMDs may offer a strategic window to manage taxable income levels.
PERIODS WHEN TAXABLE INCOME CAN BE INTENTIONALLY MANAGED
Strategic timing allows for filling up lower tax brackets efficiently over multiple years.
There May Be Years When a Roth Conversion Is More Attractive Than Others
Individual circumstances and tax consequences vary. Consult with a qualified tax professional before making any conversion decisions.
TEMPORARY LOWER-INCOME YEARS
Years where income is lower due to career transitions or early retirement might reduce the immediate tax cost of a conversion.
ESTATE AND LEGACY PLANNING CONSIDERATIONS
Conversions can be a powerful tool for leaving tax-free assets to heirs, potentially reducing their future tax burden.
YEARS BEFORE SOCIAL SECURITY BEGINS
Executing conversions before Social Security benefits start may minimize the tax ripple effect on those benefits.
CONCERN ABOUT FUTURE TAXABLE RETIREMENT INCOME
If you anticipate tax rates may rise in the future, paying taxes today at current rates could be advantageous.