Why Roth Conversion Planning Is Important At Retirement

By Betsy Cunagin, CFP®, CRPC®

Wealth Manager, Principal

March 25, 2023

With the SECURE Act 2.0 delaying Required Minimum Distributions to age 73, and higher marginal brackets a likely reality in the near future, annual income tax planning has become even more important.

 

It’s human nature to defer paying taxes for as long as possible. We all hope for a refund versus a tax bill in April. However, this approach may be too simple.

 

Most companies, non-profits and government entities offer a retirement plan that allows workers to save on a pre-tax basis. The IRS incentivizes working Americans to save for retirement by reducing their tax bill during earning years, when their tax liability is often higher. On the flip side, the IRS limits the timeframe for these accounts to grow without any tax liability. Beginning in 2023, a minimum withdrawal is required annually for all IRA investors age 73 and over. This is referred to as the RMD (required minimum distribution).

 

The timeframe between retirement when earnings drop off and 73 (the gap years) creates an opportunity for income tax planning, specifically Roth conversions.

Let’s look at an example:

 

A couple has saved $3.5 million in their combined 401k and 403b plans at work (now in Rollover IRAs). They’ve also saved $800k in a joint brokerage account. Projections look favorable for this couple to retire early at age 60.

 

The couple assumes living expenses will be covered from the brokerage account and not the IRAs once they retire. They don’t like paying taxes (who does?), so they prefer to wait until age 73 to withdraw from the tax-deferred accounts. When drawing from the brokerage account, their only tax liability would be the income (dividends and interest) and capital gains, which would keep their marginal bracket low. With this approach, their taxes would remain low in this early phase of retirement, but the IRA rollovers will continue to grow a tax deferred liability for another twelve years.

 

An additional thirteen years of growth in their IRAs is projected to increase the couple’s marginal bracket the first year an RMD is required at age 73. By 82, their marginal bracket is projected to jump again.

 

Rather than delaying withdrawals from the IRA, another more tax efficient approach is to begin Roth conversions the first full year of retirement.

This couple has the benefit of over a decade to convert annual amounts from the rollover IRA to a Roth IRA. Annual projections can be run to determine the appropriate amount to convert – starting with a conversion amount to fill up their current marginal bracket. A decade of otherwise tax deferred growth would now grow tax free in the Roth.

 

While deferring taxes before they are required feels more comfortable, paying taxes before they are due through a calculated multi-year Roth conversion plan could save a tremendous amount of tax, affecting not only the couple, but their children.

 

Tax Planning is also an important part of your legacy

Assuming that leaving an inheritance is important, Roth conversion planning will lower the tax bill for children inheriting IRAs. Prior to 2019, adult children inheriting tax deferred IRAs had the ability to use their own life expectancy to make withdrawals, so RMDs could be made over multiple decades, thereby spreading the tax liability over their lifetime. The Secure Act eliminated the “Stretch IRA,” and now tax deferred IRAs, most likely inherited during prime earning years, must be withdrawn over 10 years.

 

Roth IRAs on the other hand, grow tax free. There is no tax assessed on the earnings within a Roth IRA and tax on the principal has already been paid through the conversion. With recent proposals to increase marginal brackets (and significant bracket compression), along with the elimination of the Stretch IRA, Roth conversion planning should be considered.

 

Contact an Experienced Wealth Management Advisor Near You

We are proudly a fee-only, independently-owned financial planning firm that acts as a fiduciary for our clients. We have built our organization to put our customers’ interests first, as evidenced by our fee-only fee structure and fiduciary responsibility.

If you’re interested in our services, please contact us. If you would like to learn more about financial planning, wealth management, and finding a financial advisor, please visit other areas of our education section.

Contact us

"*" indicates required fields

Choose the one that fits you best:*
Approximately how much are you looking to have managed?*
(Modera has a $1M minimum.)

By sending this message, you agree that Modera will use the personal information you disclose to have an adviser contact you and/or you agree to opt-in to receive marketing communications from us.

This field is for validation purposes and should be left unchanged.

Modera Wealth Management, LLC (“Modera”) is an SEC registered investment adviser. SEC registration does not imply any level of skill or training. Modera may only transact business in those states in which it is notice filed or qualifies for an exemption or exclusion from notice filing requirements. For information pertaining to Modera’s registration status, its fees and services please contact Modera or refer to the Investment Adviser Public Disclosure Web site (www.adviserinfo.sec.gov) for a copy of our Disclosure Brochure which appears as Part 2A of Form ADV. Please read the Disclosure Brochure carefully before you invest or send money.

This article is limited to the dissemination of general information about Modera’s investment advisory and financial planning services that is not suitable for everyone. Nothing herein should be interpreted or construed as investment advice nor as legal, tax or accounting advice nor as personalized financial planning, tax planning or wealth management advice. For legal, tax and accounting-related matters, we recommend you seek the advice of a qualified attorney or accountant. This article is not a substitute for personalized investment or financial planning from Modera. There is no guarantee that the views and opinions expressed herein will come to pass, and the information herein should not be considered a solicitation to engage in a particular investment or financial planning strategy. The statements and opinions expressed in this article are subject to change without notice based on changes in the law and other conditions.

Investing in the markets involves gains and losses and may not be suitable for all investors. Information herein is subject to change without notice and should not be considered a solicitation to buy or sell any security or to engage in a particular investment or financial planning strategy. Individual client asset allocations and investment strategies differ based on varying degrees of diversification and other factors. Diversification does not guarantee a profit or guarantee against a loss.

Certified Financial Planner Board of Standards, Inc. (CFP Board) owns the certification marks CFP®, CERTIFIED FINANCIAL PLANNER™, and CFP® (with plaque design) in the United States, which it authorizes use of by individuals who successfully complete CFP Board’s initial and ongoing certification requirements.