Roth Conversions in Retirement: A Guide to Lowering Your Taxes

A Roth conversion is a strategic financial maneuver where you transfer funds from a traditional, pre-tax retirement account—like a 401(k), 403(b), or traditional IRA—into a post-tax Roth IRA. The core difference lies in the tax treatment: you pay income taxes on the converted amount in the year of the conversion. In exchange, all future qualified withdrawals from the Roth IRA are completely tax-free. This is in stark contrast to a traditional IRA, where you get a tax deduction on your contributions, but you pay income tax on all withdrawals in retirement.

Essentially, you are choosing to pay taxes now to enjoy tax-free income later. This can be a powerful tool for retirees who anticipate being in a similar or higher tax bracket in the future, or for those who simply want the peace of mind that comes with having a bucket of tax-free money to draw from in their later years. The IRS allows you to convert funds from a traditional, SEP, or SIMPLE IRA to a Roth IRA. The converted amount is generally subject to your ordinary income tax rate.

The primary motivation for a Roth conversion in retirement is to create a source of tax-free income. This can be incredibly valuable for a number of reasons. First, it provides a hedge against the risk of rising tax rates. If tax rates go up in the future, your Roth IRA withdrawals will be shielded from those higher rates. Second, having a mix of taxable and tax-free income sources gives you greater flexibility in managing your retirement income and tax liability from year to year. For example, in a year where you have large, unexpected expenses, you can draw from your Roth IRA without increasing your taxable income.

Another key benefit is that Roth IRAs are not subject to Required Minimum Distributions (RMDs) for the original owner. This means you can let your money continue to grow tax-free for as long as you live, and you can pass it on to your heirs tax-free as well. This makes the Roth IRA a powerful estate planning tool. According to the IRS, you can leave amounts in your Roth IRA for as long as you live. The account or annuity must be designated as a Roth IRA when it is set up.

The SECURE Act 2.0 recently increased the RMD age to 73, and it's set to rise to 75 in 2033. This delay provides a larger window of opportunity for retirees to execute Roth conversions. Converting before your RMDs begin is a key strategy because RMDs themselves are taxable income. By converting some of your traditional IRA funds to a Roth IRA in the years leading up to age 73 (or 75), you can reduce the balance of your traditional IRA. A smaller traditional IRA balance means smaller future RMDs, which in turn means a lower future tax bill.

This strategy is particularly effective in the “gap years” between retirement and the start of RMDs. During this period, your taxable income may be lower than it was during your working years, and lower than it will be once RMDs and Social Security benefits kick in. This creates a sweet spot for conversions, allowing you to pay taxes on the converted amount at a potentially lower rate. For example, if you retire at 65 but your RMDs don't start until 73, you have eight years to strategically convert funds at a potentially lower tax rate.

A Roth conversion can lower your future tax bill in several ways. As mentioned, it reduces your future RMDs, which directly reduces your future taxable income. But the benefits don't stop there. By strategically managing your taxable income in retirement, you can also potentially avoid or reduce the amount you pay in Medicare Part B and Part D premiums. These premiums are subject to the Income-Related Monthly Adjustment Amount (IRMAA), which is a surcharge for higher-income retirees. By keeping your modified adjusted gross income (MAGI) below the IRMAA thresholds, you can save a significant amount of money on healthcare costs in retirement.

Furthermore, by paying taxes on a portion of your retirement savings now, you are essentially locking in today's tax rates. If you believe that tax rates are likely to be higher in the future, a Roth conversion can be a smart way to protect your retirement savings from those higher rates. It's a proactive approach to tax planning that can pay significant dividends down the road. For 2025, the IRMAA thresholds start at $106,000 for a single person and $212,000 for a married couple. A large RMD could easily push you over these thresholds, triggering higher Medicare premiums.

Understanding the federal income tax brackets is crucial when planning a Roth conversion. The goal is often to convert just enough to ‘fill up’ your current tax bracket without pushing yourself into a higher one. Here are the projected tax brackets for 2025 and 2026, which can help you plan your conversion strategy. Please note that these are based on inflation adjustments and are subject to change.

2025 Federal Income Tax Brackets

2026 Federal Income Tax Brackets

Source: Fidelity. These brackets are for illustrative purposes. Consult a tax professional for the latest information.

Let's consider a hypothetical couple, John and Jane, both age 68. They have a combined $1 million in their traditional IRAs and plan to retire at age 70. They are in the 22% federal tax bracket. If they do nothing, their RMDs at age 73 could be substantial, potentially pushing them into a higher tax bracket and triggering IRMAA surcharges. To mitigate this, they could start a series of partial Roth conversions. For example, they could convert $50,000 per year for the next four years. This would move $200,000 into a Roth IRA, generating a tax bill each year, but at their current 22% rate. By the time they reach RMD age, their traditional IRA balance will be lower, resulting in smaller RMDs and a lower overall tax burden in their later years. They will also have a significant bucket of tax-free money to draw from in retirement.

While Roth conversions offer many benefits, they are not without risks. The most significant is the upfront tax bill. You need to have the funds available to pay the taxes on the converted amount, and it's generally not advisable to use the retirement funds themselves to pay the tax. Additionally, a large conversion could push you into a higher tax bracket for the year, resulting in a larger-than-expected tax liability. It's also important to remember that Roth conversions are irreversible. Once you convert, you can't undo it, even if the market goes down and the value of your converted assets decreases.

Another consideration is the 5-year rule. For each conversion, a separate 5-year clock starts. If you withdraw earnings from a converted Roth IRA before the 5-year period is up, those earnings may be subject to taxes and penalties. This is why it's important to plan your conversions carefully and ensure you won't need to tap into the funds for at least five years. This rule is especially important for retirees who may need to access their funds sooner rather than later.

Executing a Roth conversion is a relatively straightforward process. Here are the general steps:

1. Open a Roth IRA: If you don't already have one, you'll need to open a Roth IRA at a financial institution of your choice.
2. Initiate the Conversion: You'll then instruct your traditional IRA custodian to transfer funds to your new Roth IRA. This can often be done online or with a simple form. You can convert all or a portion of your traditional IRA.
3. Pay the Taxes: The converted amount will be treated as taxable income in the year of the conversion. You'll need to be prepared to pay the resulting tax bill. You can either make estimated tax payments throughout the year or pay the full amount when you file your tax return.
4. File Form 8606: When you file your taxes, you'll need to report the conversion to the IRS using Form 8606, Nondeductible IRAs.

It's highly recommended that you consult with a qualified financial advisor and a tax professional before initiating a Roth conversion to ensure it's the right strategy for your specific situation. They can help you analyze your financial situation, project your future income and tax liability, and determine the optimal conversion strategy for you.

This article is for educational purposes only and should not be considered financial, legal, or tax advice. Annuities are insurance products and are not insured by the FDIC or any federal government agency. Annuity guarantees are backed solely by the financial strength and claims-paying ability of the issuing insurance company. Retire Wizard is an annuity advisor matching service, not an insurance company. Consult a qualified financial advisor and tax professional for personalized guidance.