I'm a Financial Planner: If You're Converting to a Roth IRA, Don't Do It Like This
You might want to convert all of your retirement savings to a Roth in one go, but you could end up paying hundreds of thousands more in taxes than you'd have to.
"I have $3 million saved for retirement — and I'm going to convert it all to a Roth."
That was the statement someone made when they called to inquire about working with our team. The guy had read one of my previous articles on Kiplinger, "Why I Love Roth IRAs and Roth Conversions," and he was fired up.
He said he was convinced tax rates would go up in the near future and that now was the time to take advantage of lower taxes.
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After talking with him about his goals for a bit, we pulled out our calculator and ran some quick numbers. Based on his current tax rates, we saw that he would pay over $1 million in taxes if he converted everything today.
This wasn't the news he was hoping for, but he still thought he could benefit from converting some of his money and paying the taxes today.
I liked his mindset, but he was missing part of the equation. Doing a Roth conversion is about paying your taxes at the lowest tax rate possible, not about paying all your taxes now vs later.
Not the best scenario
Converting all of his savings now would have forced him into the highest tax bracket, resulted in other taxes (such as the net investment income tax, or NIIT) and pushed him into the highest Medicare tier — all things he wanted to avoid.
We suggested he look at a plan for converting his tax-deferred money into a Roth IRA over time instead of all at once. This way, he could lessen the tax hit now but still take advantage of the benefits of a Roth conversion.
Many consider a big benefit of a Roth conversion to be the opportunity to possibly pay taxes at a lower rate, since most expect taxes to go up in the future.
Especially with the current lower taxes due to the One Big Beautiful Bill Act (OBBBA) and knowing our current economic scenario with the U.S. having nearly $39 trillion in debt.
Raising taxes is an obvious way to increase revenue, which can help combat this growing issue.
An added benefit of a Roth conversion
Another reason to convert to a Roth is that it provides diversification. The idea of diversifying your account types is similar to diversifying your investments.
You probably don't have all your money in one stock, right? No, you probably have it spread out among different investments in different asset classes.
If you have all your money in tax-deferred accounts (such as a 401(k) or IRA), then all your income will be taxable when it's time to start taking withdrawals.
But since withdrawals from a Roth aren't taxable, you'll end up reducing your taxable income if you convert at least some of your money.
You may also want to keep some of your money in tax-deferred accounts to take advantage of the standard deduction. This is the amount of tax-free money the federal government lets you take each year.
While this amount changes each year, the standard deduction offsets some of your taxable income.
You may also be able to take advantage of some itemized deductions, such as medical expenses or charitable gifts. You won't be able to write off these items if you don't have any taxable income.
Do I think tax rates will go up in the future? I do. If tax rates rise, those who have been diligent savers over the years and have most of their money in tax-deferred investments could end up paying much more in taxes when they take withdrawals later.
A Roth conversion isn't for everyone
But while I agree that aggressive Roth conversions could make sense right now for the right people, it's not the solution for everyone.
The key is to work with a professional adviser who provides comprehensive planning to help you calculate how much you can convert to avoid paying too much in taxes today.
Not all advisers use advanced planning software to compute taxes and uncover the potential impact to Social Security taxes, capital gains or Medicare premiums, so it is important to ensure your team is doing this level of tax planning.
Back to the guy at the beginning of this article. We were able to find a sweet spot between converting too much (and incurring a higher tax bill today) and converting too little (where it didn't make a big difference for his future tax bills).
I told him he was wise to start thinking about this now because the clock is ticking and the window to take advantage of lower rates could close in the future.
If you're concerned about paying too much in taxes in retirement, I urge you to work with a financial adviser who can help you pinpoint if a Roth conversion is right for you and find your own sweet spot.
You could end up saving hundreds of thousands of dollars over your retirement — and making sure you have the income you need to cover a retirement that spans 10, 20 or even 30 years (if you want to learn more, you can request a free copy of my bestselling book on tax planning).
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