What is a Roth conversion?

A Roth conversion is the process of transferring pre-tax retirement funds from a traditional IRA or 401(k) into a Roth IRA, paying taxes on the converted amount now in exchange for tax-free withdrawals in retirement.

This strategy is ideal for individuals who expect to be in a higher tax bracket later, have the cash to cover the tax bill, and want to minimize future required minimum distributions (RMDs). It can be especially beneficial during low-income years, market downturns, or before RMDs begin at age 73.

Case Study: Roth Conversion Strategy for a Married Couple with $150K Income

David and Susan, a retired couple (both 65 years old), have a taxable income of $150,000 from a mix of pension payments, dividends, and capital gains from stock sales. They have not started taking social security benefits. They want to convert a portion of their traditional IRA to a Roth IRA but want to stay within the 22% tax bracket to avoid jumping into the 24% bracket.

Tax Bracket Analysis (2024 Married Filing Jointly):

Since David and Susan have $150,000 of taxable income, they can convert up to:

• $201,050 - $150,000 = $51,050 while staying fully within the 22% tax bracket.

They decide to convert $50,000 to a Roth IRA.

Immediate Tax Cost of Conversion:

• $50,000 at 22% tax rate = $11,000 in federal taxes

• Potential state taxes may apply, depending on your location.

• They will need to pay this tax bill with cash, not from the converted funds, to maximize growth

Long-Term Benefit of a $50,000 Roth Conversion:

Assuming their Roth IRA grows at an average of 7% annually and remains untouched for 20 years, the future value would be:

• $193,484 tax-free for retirement or heirs

• If left to beneficiaries, they can withdraw it tax-free over 10 years

• Avoids future RMDs on this amount

Benefits of conversion:

1. Tax-Free Growth & Withdrawals: The $50,000 conversion grows to nearly $193,484, and neither David, Susan, nor their heirs will owe taxes on it.

2. Avoids Higher Future Taxes: Tax rates are scheduled to rise in 2026 when the 22% bracket will likely increase. Converting now secures today’s lower rates.

3. Reduces Future RMDs: By moving money out of their traditional IRA, they lower taxable RMDs, reducing their future taxable income.

4. Protects Surviving Spouse from Higher Taxes: If one spouse passes, the survivor will file as single, facing higher brackets with the same RMDs. This strategy helps reduce that burden.

5. Tax-Free Inheritance: If left to their children, the Roth IRA can grow for another 10 years tax-free under the SECURE Act rules.