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By S. Joseph DiSalvo, ChFC, and Marie L. Madarasz, AIF

Should you consider converting your IRA into a Roth IRA? The decision to initiate a Roth IRA conversion depends on your personal and financial situation. However, it's not an "all or nothing" proposition — consider a partial conversion. Although you may have been prohibited from contributing to a Roth IRA due to income limits, anyone (regardless of income levels) is eligible to do Roth conversions.

S. Joseph DiSalvo, ChFC®, and Marie L. Madarasz, AIF®S. Joseph DiSalvo, ChFC and Marie L. Madarasz, AIF, authors of “Income for Life, the Retiree's Guide to Creating Income from Savings,” specialize in coordinating a retiree’s income, investment and tax planning. They are members of Ed Slott’s Elite IRA Advisor Group, a prestigious study group which enhances their knowledge of IRA distribution planning. Both are strong advocates of financial education, seeking to teach others how to achieve sustained success and lifelong prosperity.

Marie Madarasz & Joe DiSalvo

Partial Roth conversions are, very simply, a strategy to reduce taxes on your “never-been-taxed” retirement accounts. Roth conversions trigger an immediate tax liability. The trade-off is the big tax benefit down the road. If you follow the rules for qualified Roth IRA distributions, all your Roth IRA funds, including the earnings, will be tax-free when distributed. Not a bad deal!

Paying taxes before you need to goes against what you have always been told — defer, defer, defer! However, this conventional wisdom may no longer be the best advice. A more strategic approach, such as paying the tax on your own schedule instead of Uncle Sam’s, may help you pay less tax and extend the longevity of your wealth.

1. You May Have Been Too Efficient at Tax Deferral

If you are a successful saver who retires with more than a million dollars in your IRA, you face a new challenge. How do you get the money out of these accounts and pay the least amount of tax possible?

You have been told to defer tax in your saving/working years and in retirement you can withdraw the money while in a lower tax bracket. This is a good plan; however, this is often not the case. For several years after you retire, you may see a lower tax bracket. But, when you leave your retirement accounts to grow and compound until age 72, the required minimum distributions (RMDs), when combined with Social Security and other types of income (such as taxable dividends and capital gains), are often high enough to push you into an equivalent or a higher tax bracket than you were in during your working years. And, deferring the tax when you are in, as an example, a 24% tax bracket, and then taking distributions when you are in a 32% tax bracket makes no financial sense!

2. Your Taxes are Going Up by Law

The Tax Cuts & Jobs Act of 2017 (TCJA) ushered in some of the lowest tax rates we have seen since the 1920s and 1930s, however, these low rates sunset (expire) at the end of 2025. Come January 1 of 2026, tax rates, as the law was written, will go back to the higher rates that existed prior to TCJA. Furthermore, one must consider the very real possibility of even significantly higher taxes in the future: As a country we have amassed over $30.3 trillion dollars in debt (as of March 2022). Therefore, you shouldn’t miss the opportunity of exploring partial Roth conversions during these historically low tax years.

3. When You Control Taxable Income, Tou Control other “Stealth Taxes”

Controlling your taxable income will also control other “stealth” taxes that are income-based, such as Medicare surcharges, net investment income tax, AMT, etc. In our experience, nobody expects or enjoys higher Medicare premiums! A Roth IRA conversion will increase your income the year you convert, but in the following years, it potentially lowers your taxable income by reducing pre-tax balances and therefore, future RMDs. Although Roth IRAs have no required distributions during the original owner’s lifetime, you can choose to take distributions as a source of future tax-free income.

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4. Mitigate the Widows Penalty

Reducing the number of future RMDs by using partial Roth conversions will help a surviving spouse who, unfortunately, will face the “widow’s penalty.” The widow’s penalty is often an unexpected and unwelcome surprise to a surviving spouse who has not had to deal with the disadvantages of being a single tax filer for decades. The reality is our tax code benefits the married filer, often resulting in higher tax liability for the surviving spouse even though they may have less income. Doing partial Roth conversions while both spouses are alive (and married filing joint) will be a gift that helps reduce the tax burden for the surviving spouse.

5. The SECURE Act Changed the Game for Your Beneficiaries

The SECURE Act is the largest retirement legislation passed in decades, and you may not be familiar with it or what it means. This is a money grab on your retirement accounts, and it changed the game in the fourth quarter for your beneficiaries.

Post the SECURE Act most non-spouse beneficiaries will have 10 years to empty their inherited IRAs or face a 50% penalty of any remaining account balance. It makes leaving your heirs your pre-tax money less advantageous than in the past when they could “stretch” their distributions over their lifetimes. This will push most non-spouse beneficiaries into higher tax brackets during their peak earning years. Your hard-earned money will be subject to some of the highest tax rates possible. Although the 10-year rule applies to inherited Roth IRAs as well, all the distributions taken will be tax-free.

Roth IRAs have always been an attractive way to save for retirement. Partial Roth conversions provide all income levels access to Roth IRAs and allow you to have control over when you pay tax and the amount of tax you ultimately pay.

If you are lucky, taxes will be your largest expense in retirement (if not, it will be healthcare). Paying less in tax means your wealth will last longer. Done correctly, partial Roth conversions will benefit you during your lifetime and allow you to leave a tax-free legacy as well. Consider partial Roth conversions within the context of a comprehensive financial plan. The strategy of when and how to implement them will be different for everyone and will depend on your unique circumstances. Like anything related to pre-tax retirement accounts, the rules are complex; seeking qualified advice before you move forward is highly recommended.

About the authors: S. Joseph DiSalvo and Marie L. Madarasz

S. Joseph DiSalvo, ChFC, and Marie L. Madarasz, AIF, authors of "Income for Life, The Retiree's Guide to Creating Income from Savings," specialize in coordinating a retiree’s Income, investment and tax planning. They are members of Ed Slott’s Elite IRA Advisor Group, a prestigious study group which enhances their knowledge of IRA distribution planning. Both are strong advocates of financial education, seeking to teach others how to achieve sustained success and lifelong prosperity.