How to Manage Roth Conversions Before Taxes Increase

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In this episode of Ready for Retirement, we’re talking about how to manage Roth conversations before taxes, especially if you have a 401K.

Questions Answered:

How important are Roth conversations?
Why do people make Roth conversions?
How much should I be converting, especially since tax legislation may change?
Should I roll my 401K into my Roth IRA?

Episode Timeline:

03:31 – The goal of and strategy behind Roth conversions

09:31 – Carl’s example: Should I roll my 401k into my Roth IRA?

18:14 – Summary of key takeaways

Key Takeaways:

What is the goal of Roth conversions?
- The goal is to pay taxes at a lower tax bracket.
- When you’re in retirement, you have control over when you pull funds out of your investments and how you recognize income, especially if you have different types of accounts. Thus, you have the ability to control how much you pay in taxes each year when you’re pulling money out of your investment accounts. That control lessens when you turn 72 because you’ll be required to take funds out of any pre-tax accounts you have.
Golden Question: Should I start pulling funds from my Roth when I turn 72 or should I be doing conversions along the way to pay taxes at a lower tax bracket and avoid the bigger tax hit I’m going to face in the future?
- At the end of 2025, unless new legislation is passed before then, current tax law is going to expire. Each tax bracket will go up around 3-4% on average.
- If your current and future tax brackets are the same, it really doesn’t matter when you pull funds from your Roth.
- Rolling your 401K into a Roth would make it a fully taxable conversion.
- If you live in a state with state income taxes, make sure to factor in that as well.
- If Carl rolls over $900,000 from his 401K, his taxes paid would be $300,000, so his effective tax rate would be 33%.
- You should also be aware of your marginal tax bracket, which says for each additional $1 you convert, what tax rate are you paying taxes at for that $1? For Carl, it would be 37%.
- To find out if Carl should roll over his 401K to his Roth, he should also figure out what his future might look like if he didn’t.
Points to Consider
- Current tax brackets and the current value of your IRA are major variables that can change your required minimum distribution (RMD).
- Who knows if tax rates will be the same, higher, or lower in the future! This is important to look at when considering if a Roth conversion makes sense.
Summary – What to focus on moving forward
- Optimize your finances by only making Roth conversions that make sense (at a lower tax rate).
- We don’t know what taxes will be like in the future, so it could make sense to look at conversions as tax insurance to mitigate worst case scenarios. Conversions could be your way of saying that you’re willing to pay this level of taxes today in order to protect against what might happen later.
- Conversions aren’t for everyone! If you don’t have a substantial pre-tax portfolio, you might be stressing out too much about Roth conversions. Don’t let it take up too much of your attention.
- Consider qualified charitable distributions to offset the implications of RMDs, re-evaluating asset location, or reframe the fear you have around RMDs.