Most people ask whether they should do a Roth conversion. That's the wrong question. The real question is how much.
To show why, I took one couple with $1.2 million in retirement accounts and ran a Roth conversion three different ways. One way saved them about $51,000. One way cost them more than doing nothing at all. The only difference was the amount.
A Roth conversion in plain English
Most people have their retirement savings in an account they haven't paid tax on yet. Every dollar that comes out of it later gets taxed.
A Roth conversion means moving some of that money into a Roth account and paying the tax on it this year. After that, it grows tax-free and it's never taxed again. Not for you, and not for your kids.
So the question isn't whether you'll pay the tax. You will. The question is when, and at what rate. This year's deadline is December 31, but the firm holding your money usually needs the request earlier, sometimes by mid-December.
Meet Mike and Linda
Mike and Linda are an example couple, close to the families I sit down with every week:
- Both 66
- $1.2 million in retirement accounts they haven't paid tax on
- $200,000 in regular savings
- About $60,000 a year from Social Security, together
- They spend about $90,000 a year
Plan 1: do nothing
They just take what they need to live on. For the next nine years this looks great. Their tax bill is tiny, some years only a few hundred dollars.
Then at 75, the government makes them start pulling money out every year whether they need it or not. Because the account kept growing untouched, those forced withdrawals are big, and they get bigger every year. Their taxable income jumps and stays up for the rest of their lives.
Adding up federal taxes and Medicare surcharges over their whole retirement, doing nothing costs them about $227,100.
Plan 2: the right amount
If you're 65 or older, there's one number to know: $150,000. There's a new tax deduction for anyone 65 and up, $6,000 a person or $12,000 for a married couple. Once your income goes over $150,000 for a married couple, it starts shrinking. A Roth conversion counts as income.
For Mike and Linda, the sweet spot was converting about $67,000 a year. That kept their income just under $150,000, so they kept the whole deduction and stayed well clear of the Medicare surcharge. The tax on each year's conversion was about $11,400, roughly 17 cents on every dollar moved.
The new deduction ends after 2028, so from 2029 on the right amount drops to about $55,000 a year. They keep going until 74, the year before forced withdrawals start: nine years and a little over half a million dollars moved.
Lifetime taxes and surcharges: about $176,400. That's about $51,000 less than doing nothing, and their kids inherit about $73,000 more.
Plan 3: converting as much as possible
This is the one I see people do on their own. They converted as much as they could each year, right up to the line where Medicare starts charging more, and emptied the whole account into a Roth in nine years. It felt aggressive and smart.
They paid more in total tax than if they had done nothing. To move that much, they paid 22 cents on the dollar. If they'd waited, most of that money would have come out at 12 cents. They paid a higher rate now to dodge a lower one later.
Lifetime taxes and surcharges: about $235,200.
The full picture
- Do nothing: $227,100
- The right amount: $176,400
- Too much: $235,200
Where most of the savings came from: the widow's tax
When one spouse dies, the tax bill usually goes up, not down. In this example, Mike passes away at 84 and Linda lives to 92. She still has the same retirement account, but now she files taxes as a single person, with tax brackets about half the size. And one of their two Social Security checks has stopped.
Same money, higher bracket, less income. If they'd done nothing, Linda pays about $129,700 in tax in those years alone. If they'd converted the right amount in their sixties, it's about $50,000. The best time to protect your spouse from that is while you're both still here.
How to find your amount
- What tax bracket are you in now, and how much room is left before the next one?
- What bracket will you be in once forced withdrawals start at 73 or 75?
- If one of you passes away, what will the other one's taxes look like, filing alone?
- What income lines don't you want to cross? For many married couples that's $150,000 for the senior deduction, or $218,000 for the Medicare surcharge.
Then call the firm that holds your account and ask one thing: what's your cutoff for a conversion this year? Don't assume it's December 31.
The question isn't whether to do a Roth conversion. It's how much. Get the amount right and it can be worth tens of thousands of dollars. Get it wrong and you can actually lose money. If you'd like us to run your numbers the way we ran Mike and Linda's, a free call is the place to start.
