When it comes to taxes, most of us naturally focus on one question: How can I reduce my tax bill this year? Good tax planning takes a longer view. Instead of simply minimizing taxes today, the goal should be to consider how much of your wealth may ultimately be lost to taxes over your lifetime. For some investors, Roth conversions can be an important part of that strategy.

What Is a Roth Conversion?

A Roth conversion involves moving money from a tax-deferred retirement account, such as a Traditional IRA, into a Roth IRA.

The tradeoff is relatively straightforward: the amount converted is generally taxable as ordinary income in the year of the conversion. In exchange, those assets can potentially grow tax-free, qualified Roth withdrawals are tax-free, and Roth IRAs are not subject to required minimum distributions (RMDs) during the original owner’s lifetime.

In other words, a Roth conversion gives you something unusual in tax planning: some ability to choose when you pay the tax.

The question isn’t simply whether to convert. It is when to convert and how much.

Why Consider a Roth Conversion?

Imagine retiring at age 65 but not being required to take distributions from your retirement accounts for several more years. Your taxable income during that period could be substantially lower than it was during your working years and potentially lower than it will be once Social Security, pensions and RMDs are all generating taxable income.

That window may create an opportunity. By intentionally converting a portion of an IRA during lower-income years, you may be able to pay tax at a comparatively favorable rate today rather than potentially paying a higher rate later.

Conversions may also help:

• Reduce future RMDs and taxable retirement income.
• Create a source of tax-free retirement income.
• Provide greater control over future tax brackets.
• Potentially reduce exposure to Medicare IRMAA surcharges in future years.
• Improve tax diversification between taxable, tax-deferred and tax-free accounts.
• Provide potentially more tax-efficient assets for heirs.

This doesn’t mean paying taxes sooner is always better. The potential benefit comes from paying tax at the right time and at an appropriate rate.

How Do You Know if a Conversion Makes Sense?

A Roth conversion should generally be evaluated as part of the broader financial plan rather than in isolation.

Some of the questions we consider include:

What is your marginal tax rate today?
We first want to understand how much additional income could be recognized before reaching a higher tax bracket.

What might your tax rate look like later?
Projected retirement income, Social Security, pensions, investment income and future RMDs can help us estimate the potential tax environment later in life.

Are you currently in a lower-income planning window?
Retirement, a career transition, or the years before Social Security and RMDs begin can sometimes create attractive conversion opportunities.

How large could future RMDs become?
A substantial tax-deferred balance can eventually create significant mandatory taxable distributions. Conversions today can reduce the amount remaining subject to future RMDs.

Can the conversion tax be paid from assets outside the IRA?
When practical, paying the resulting tax from other resources allows more of the converted retirement assets to remain invested in the Roth.

What other tax consequences could be triggered?
A conversion increases taxable income and can affect Medicare premiums, capital gains, Social Security taxation, deductions, credits and other income-related thresholds.

What are your estate and charitable goals?
Traditional and Roth accounts can have very different implications for beneficiaries and charitable giving, making these goals an important part of the analysis.

It’s Not an All-or-Nothing Decision

One of the biggest misconceptions about Roth conversions is that the decision is simply whether to convert an IRA or leave it alone. In practice, a series of partial conversions over several years may make more sense.

For example, someone could deliberately convert enough each year to use available room within a targeted tax bracket without unnecessarily pushing income into the next bracket or triggering other undesirable tax consequences.

That makes Roth conversion planning an ongoing process rather than a one-time decision.

What About a Backdoor Roth?

Higher-income households may face income limitations that prevent them from making direct Roth IRA contributions. Under current tax rules, a “Backdoor Roth IRA” may provide another pathway to getting money into a Roth.

Certain employer retirement plans may also allow substantially larger after-tax contributions that can potentially be converted to Roth through a strategy commonly called a Mega Backdoor Roth.

These strategies can be particularly valuable because they may allow additional dollars to begin compounding within a tax-free account. However, the rules can be complex including the IRA pro-rata rule that should be reviewed carefully before implementation.

The Bigger Picture

Roth conversion planning isn’t necessarily about avoiding taxes. It’s about deciding when paying taxes may be most advantageous.

For the right household, voluntarily recognizing some taxable income during lower-tax years may help reduce future RMDs, improve retirement flexibility and potentially reduce the amount of wealth ultimately lost to taxes.

That’s why we believe the better question isn’t simply, “How can I pay less tax this year?”

It’s “How can I make thoughtful tax decisions today that may help me keep more of my wealth over my lifetime?”

This information is provided for educational purposes and should not be considered individualized tax advice. Roth conversions can have significant tax consequences, and individual circumstances vary. CWA is not a CPA firm, and we recommend coordinating tax strategies with your qualified tax professional when appropriate.

Advisory services are offered through Collective Wealth Advisors LLC, a Registered Investment Adviser with the SEC. For informational and educational purposes only and should not be construed as specific investment, accounting, legal, or tax advice. Certain information is based upon third party data which may become outdated or otherwise superseded without notice. Third party information is deemed to be reliable, but its accuracy and completeness cannot be guaranteed. Neither the Securities and Exchange Commission (SEC) nor any other federal or state agency have approved, determined the accuracy, or confirmed the adequacy of this article.