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7 Roth Conversion Considerations for Recent Retirees

Estate Planning Investment Planning Tax Planning Retirement Planning

One of the most common things that our recently retired clients ask us to do is to help them convert as much of their traditional IRAs into Roth IRAs as quickly as possible.  Our job is to help them build a strategy that allows them to pay as little in taxes over the course of their lifetime.  Each year, as part of our tax planning appointment, we review that year’s tax projection to make sure that our Roth conversion amount is in line with expectations.  If there are unexpected changes, we factor those in and change our Roth conversions appropriately.  While each client’s situation (and each Roth conversion strategy) is unique, here are seven things we take into consideration with every client: 

  1. Timeline 

For most people, it doesn’t make sense to do all of your Roth conversions in one year.  Doing this would force you into paying all of your taxes in one year, and probably would send you in a higher tax bracket than if you spaced this out over time.  For most people, a reasonable timeline is between retirement (when your taxable income should go down) and when you reach age 72, when you have to start taking required minimum distributions.   

If you retire in your late 50s or early 60s, you’re simply going to have more time to make Roth conversions at a lower tax bracket than if you retire later on.   

  1. Account balances 

This is pretty simple.  The more money you have in your traditional IRAs and pretax workplace retirement plans (like 401ks, 403bs, and 457 plans), the more difficult it will be to convert everything at a desirable tax bracket.   And the more important it is to have a deliberate plan in place to do so.  When we help our clients, we take all retirement plan accounts into consideration as part of our planning. 

  1. Tax bracket 

Our goal is to help our clients convert as much as possible at a desirable tax bracket. Depending on your tax situation, a desirable tax bracket might be as low as 12%, or as high as 32%.  For some clients, we are able to convert all of their IRA and 401k amounts into a Roth IRA at the 12% tax bracket.  For others, we have to settle for paying taxes at a 32% in order to avoid paying taxes at 35% or 37% (or higher) down the road.   

We usually present something like this fictitious client example: 

You have about $2 million in IRA assets.  Since you’re both 60, you have 12 years to convert as much as you can before having to take required minimum distributions (RMDs).  Based upon your other sources of income, we believe you can convert these amounts at the following tax brackets before you reach age 72: 

  • 12%:  $70,000 per year (or $700,000 total) 

  • 22%:  $160,000 per year (or $1.6 million total) 

  • 24%:  100% of your account balances 

While this might change, we’ll also be making adjustments each year to account for those changes.  Based on this analysis, which tax bracket would you feel most comfortable with?   

That way, our clients have control over what tax bracket they’d like to stay in, while we have a target when we do our annual tax projection.   

  1. Social Security planning 

Another consideration is future sources of income.  Most people retire with the assumption that they won’t make that much after leaving their salaried job.  While that might be true for some people, many folks are (pleasantly) surprised when they find their income to be higher than it was before.  Part of this is simply from the compounding effect of their savings and investments.  However, a large part of this comes from future sources of income that they never counted on. 

Social Security is the most common example of this.  For all the bad news you might read about the Social Security Administration running out of money, it’s easy to forget that there is actual Social Security income that is paid out.  To my understanding, the Social Security Administration has not missed a payment to an eligible person.  While Social Security income is tax-preferred (not all of it is taxed), it is income that we have to incorporate into our Roth conversion planning.   

The earlier you take Social Security, the less room you have to make Roth conversions within your desired tax bracket.  With Social Security income, you either have to convert less from your IRA to stay within your desired tax bracket or be willing to accept moving into a higher tax bracket.  We incorporate this into our recommendations, not only for Roth conversions, but our Social Security planning as well. 

  1. Other sources of future income 

While Social Security is the most common future income source for retirees, it’s not the only source of income.  We also look at each client’s situation to see what other future income sources might impact them.  This could include: 

  • Pensions  

  • Annuities 

  • Inherited IRAs 

  • Income from inherited assets 

  • Deferred compensation 

  • Stock options 

  • Executive compensation and payouts 

Not only do each of these items impact our Roth conversion strategy, but there might be individual decisions that need to be made to help our clients.   

For example, a pension might come with a decision on when to take it, and which type of survivor benefit option to choose.  We help our clients decide when to take that pension and what option.  While supporting the Roth conversion strategy might be a consideration, there are other factors that might compel us into making a decision that is best for the client, but not for the Roth conversion strategy.   

Once that decision is made, we will incorporate that into our Roth conversion strategy.  What we don’t do is let the tail wag the dog—we don’t tell our clients to make a bad pension decision just to support the Roth conversion strategy. 

  1. Estate planning 

With the new tax law change, inherited IRAs must be fully distributed within 10 years.  We look at who stands to inherit our clients’ IRAs to help them understand what tax impact that might have on their beneficiaries.  Some clients might want to ensure their IRAs are fully converted because their children are high earners, and this would create a big tax problem.  Some people might have beneficiaries in a lower tax bracket, and inheriting a balance wouldn’t cause a huge concern.   

With each client, we use this as an opportunity to review beneficiary designations and talk about their estate planning. 

  1. Charitable contributions 

For our charitably inclined clients, we might decide that fully converting IRAs into a Roth account would not make sense.  Once you reach age 70 ½, you are able to make charitable contributions tax-free from your IRAs.  This is known as a qualified charitable distribution (QCD), and each person is able to contribute up to $100,000 per year from their IRAs.  This means that the money a person saves in their IRA and is eventually given to charity: 

  • Was contributed to the account without taxes 

  • Has been growing without taxes, and 

  • Will have been given to charity without taxes 

In other words, for these clients, it actually doesn’t make sense to make Roth conversions and pay taxes on money they could have avoided taxes on in the first place.  So we help our clients plan for their charitable distributions, and account for this in their Roth conversion strategy.   

Conclusion 

For many people, it doesn’t make sense to contribute to Roth IRAs while they are still working.  However, when retirement comes, this is a question that easily comes to the top of their mind.   

While it’s simple to think about what a Roth conversion strategy might look like, it becomes a little more difficult when you actually sit down to create the plan.  And it’s even more difficult to keep on top of the plan year after year.   

The first person you should talk with is your CPA or your financial advisor.  But if they can’t or won’t do it, feel free to contact us at Lawrence Financial Planning.  We’d be more than happy to schedule a complimentary phone appointment to see how we might be of service to you. 





The foregoing content reflects the opinions of Lawrence Financial Planning, LLC and is subject to change at any time without notice. Content provided herein is for informational purposes only and should not be used or construed as investment advice or a recommendation regarding the purchase or sale of any security. There is no guarantee that the statements, opinions or forecasts provided herein will prove to be correct. 
Past performance may not be indicative of future results. Indices are not available for direct investment. Any investor who attempts to mimic the performance of an index would incur fees and expenses which would reduce returns. Securities investing involves risk, including the potential for loss of principal. There is no assurance that any investment plan or strategy will be successful or that markets will recover or react as they have in the past.




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