Maximizing Roth Conversions: Essential Considerations for Early Retirees

Roth conversions have become an integral part of retirement planning over the past several years, especially for those with higher incomes throughout their years who retire early, and stockpile pre-tax assets given the better tax advantage they receive with a high income.  This leads to a long window of time to complete Roth conversions to potentially reduce or eliminate future RMDs and smooth out/reduce taxation.  

Below are some considerations for maximizing efficient conversions:

The true unknown is how tax laws will play out over 10-20 years

Tax Laws are difficult to predict, and even more uncertain with the current administration’s rapid changes.  It is important to plan with what you know now, and reevaluate over coming years.  An example of a low change that impacts Roth Conversion plans is the RMD age being pushed back.  Keep in mind that laws regarding Roth IRAs themselves can be changed too.

Don’t necessarily focus on eliminating RMDs altogether, but instead focus on smoothing out income over long periods of time.

A common theme with clients on the cusp of retirement, is the idea that RMDs need to be eliminated altogether.  I often find that effective Roth conversions are done best by aiming to spread out all income generated from a pre-tax IRA/401k over one’s lifespan (Including regular withdrawals, charitable gifts, and RMDs, vs trying to front run Roth conversions, or delaying based on perceived tax changes.  It is often helpful to showcase how really large conversions early on still can put an individual in a higher than expected tax bracket, and may not be necessary just for the sake of converting.

For larger conversions, be mindful of IRMAA Charges

Specifically for those over 65, Medicare surcharges (Income Related Monthly Adjustment Amount, or IRMAA) can apply if one surpasses a certain income threshold.  This is based on your Modified Adjusted Gross income (MAGI).

2024 Medicare Part B IRMAA Brackets:

• Individual MAGI $97,000 or less / Joint MAGI $194,000 or less: Standard premium only

• Individual MAGI $97,001-$123,000 / Joint MAGI $194,001-$246,000: Standard premium + $69.90

• Individual MAGI $123,001-$153,000 / Joint MAGI $246,001-$306,000: Standard premium + $174.70

• Individual MAGI $153,001-$183,000 / Joint MAGI $306,001-$366,000: Standard premium + $279.50

• Individual MAGI $183,001-$500,000 / Joint MAGI $366,001-$750,000: Standard premium + $384.30

• Individual MAGI above $500,000 / Joint MAGI above $750,000: Standard premium + $419.30

Here is an additional article that covers IRMAA

Be mindful of other income sources

Other income sources may be additional withdrawals from your retirement accounts, pensions, earned part time income, social security in some cases, dividends and interest from stock, realized capital gains, and rental income.  These must be factored in together when considering how much to convert.  We prefer to visualize what this can look like for clients in specific years, where income may be higher than expected, or showcase what it may look like if a client chooses to go back to work.  

Market downturns can be beneficial in Roth conversion implementation

You might think that a market downturn is not the best time to pay tax on a conversion, but there are a couple benefits.  The first is that you are still reinvesting those dollars into a Roth in a similar, if not more aggressive manner, given that the Roth IRA has a longer term time horizon.  

The second is that converting a reduced account can allow for a large percentage of the account to be converted and reduce future needed conversions to achieve whatever goal you intend with your conversions.

Have a dynamic and flexible tax strategy that adjusts to your needs over time.

With all of the above information, it is important to be flexible each year in regards to your situation changing, tax law changes, and market performance.  

Conversations regarding Roth Conversions are common at Navigate Financial Planning.  They are an integral part of planning for early financial independence and need to be revisited annually as tax laws change.  For many ongoing clients, we provide dynamic guidance on how to approach these at the onset of the initial plan, and on an annual basis as one’s plan inevitably changes.