National Retirement Security Week (NRSW) is an excellent opportunity to reflect on your financial future and evaluate how to help maximize your retirement savings strategies.
At NJM Wealth Preservation Strategies, we understand that Americans approaching retirement—particularly those who are wealthy or high-net-worth individuals (HNWIs)—face complex financial decisions. Roth conversions can be one of the most powerful tools in your retirement planning arsenal, but it’s critical to understand the potential benefits and risks before making any decisions.
In this blog, we’ll explore what a Roth conversion is, how it works, and how it could fit into your broader retirement strategy.
Please note that this information is for educational purposes only and is not meant as specific investment advice. Always consult a financial professional to assess your individual needs.
A Roth conversion is the process of transferring assets from a tax-deferred retirement account, like a Traditional IRA or 401(k), into a Roth IRA. When you convert funds into a Roth IRA, you’ll pay taxes on the amount you convert, but once the money is in the Roth account, it grows tax-free, and future withdrawals are generally tax-free, provided certain conditions are met.
For high-net-worth individuals approaching retirement, Roth conversions can offer several potential advantages, particularly as part of a long-term tax planning strategy.
To fully understand the benefits of a Roth conversion, let’s review the key differences between a Traditional IRA and a Roth IRA:
The critical advantage of a Roth IRA is that it provides tax-free income in retirement, which can be particularly valuable if you expect to be in a higher tax bracket in the future. However, it’s important to weigh the immediate tax cost of the conversion against the long-term benefits.
Roth conversions offer a range of potential benefits for individuals nearing retirement who are seeking to preserve their wealth and help optimize their tax situation:
One of the most appealing aspects of a Roth conversion is the potential for tax-free withdrawals in retirement. For wealthy retirees, this can be a strategic way to help reduce taxable income during retirement years. Tax-free income can be especially valuable if you expect your tax rate to rise in the future due to changes in tax laws or increases in personal income.
With a Traditional IRA, you are required to begin taking Required Minimum Distributions (RMDs) at age 73, which can force you to take taxable income even if you don’t need the funds. These distributions can push you into a higher tax bracket, increasing your overall tax burden in retirement.
A Roth IRA, however, does not require RMDs for the original account holder, allowing your assets to continue growing tax-free indefinitely. Converting part of your Traditional IRA or 401(k) into a Roth can help reduce the amount subject to future RMDs, potentially lowering your taxable income in retirement.
For wealthy individuals, tax diversification is as important as investment diversification. Having assets in accounts with different tax treatments—tax-deferred, tax-free, and taxable—can help give you flexibility when planning withdrawals in retirement. A Roth conversion can also help diversify your tax strategy by providing a pool of tax-free income to draw upon in retirement, giving you greater control over your taxable income each year.
A Roth IRA can also be a useful tool for estate planning. Unlike Traditional IRAs, Roth IRAs are not subject to RMDs for the original account owner, meaning you can leave your Roth assets to your heirs without depleting them during your lifetime. Additionally, beneficiaries of Roth IRAs can take tax-free withdrawals, which can be a potentially significant financial benefit to them.
Roth conversions may be particularly advantageous during years when your taxable income is temporarily lower, such as after retiring but before you start taking Social Security or RMDs. By converting during these lower-income years, you can take advantage of lower tax rates, reducing the overall cost of the conversion.
According to the Tax Policy Center, the highest federal income tax bracket in 2024 is 37%, but many high-net-worth individuals fall into lower brackets during certain periods of their retirement. Strategic timing of Roth conversions can help minimize the tax impact.
While Roth conversions offer numerous potential advantages, they are not without risks. It’s essential to consider the following factors before proceeding:
When you convert funds from a Traditional IRA or 401(k) to a Roth IRA, the amount you convert is treated as taxable income. This could significantly increase your tax liability in the year of the conversion. For example, converting $100,000 could push you into a higher tax bracket, resulting in a substantial tax bill. It’s critical to evaluate whether the long-term benefits outweigh the immediate tax cost.
A large Roth conversion could increase your Modified Adjusted Gross Income (MAGI), which is used to determine your Medicare premiums. Higher income levels can trigger Income-Related Monthly Adjustment Amounts (IRMAA), resulting in higher premiums for Medicare Part B and Part D. You’ll want to consider how a Roth conversion may impact your healthcare costs.
Roth conversions can be most beneficial when your tax rate at the time of conversion is lower than your expected tax rate in retirement. For HNWIs, predicting future tax rates can be difficult due to potential changes in income, investments, and tax laws. Careful planning is required to help ensure that the timing of the conversion aligns with your financial goals.
While the focus is often on federal taxes, it’s essential to account for state income taxes as well. Some states have no income tax, while others may tax Roth conversions. Depending on where you live, the state tax implications of a Roth conversion could be significant.
There are no limits on the amount you can convert from a Traditional IRA to a Roth IRA in a given year. However, it’s important to follow the IRS rules regarding conversions to avoid penalties. For instance, if you are under age 59 ½ and do not complete the conversion properly, you could face a 10% penalty in addition to the taxes owed.
A Roth conversion can be a valuable part of your retirement strategy, but it’s not right for everyone. For HNWIs nearing retirement, the decision to convert requires careful consideration of current and future tax rates, estate planning goals, and overall financial strategy.
At NJM Wealth Preservation Strategies, we work closely with our clients to help them understand the potential benefits and risks of Roth conversions within the context of their broader retirement plan. We believe that educational resources and informed decision-making are critical to helping you achieve long-term financial security.
If you’d like to learn more, check out Nic’s 60-second Roth Conversion video messages, each with their own set of useful tips to have on hand when you need them.
National Retirement Security Week is the perfect time to reflect on your retirement planning strategies and explore options that can help you secure your financial future. A Roth conversion may be an effective way to help optimize your tax situation, protect your wealth, and enhance your estate planning.
To learn more about how Roth conversions and other wealth preservation strategies could benefit your retirement plan, visit NJM Wealth Preservation Strategies.
This blog aims to provide educational information regarding Roth conversions and is not intended as specific financial advice.