The years between retirement and the start of Social Security and required minimum distributions (RMDs) can offer a valuable window for tax planning. With income often at its lowest, retirees may be able to convert traditional retirement savings to Roth IRAs at lower tax rates, potentially reducing their lifetime tax burden.
Done thoughtfully, Roth conversions can reduce future required distributions, provide greater flexibility over retirement income, and potentially ease the tax burden on a surviving spouse.
Here's how it works. Money converted from a traditional IRA or eligible 401(k) to a Roth IRA is generally subject to income tax in the year of the conversion. Once in the Roth IRA, that money can continue growing, and future qualified withdrawals are tax-free. Unlike traditional IRAs, Roth IRAs don't require minimum distributions during the original owner's lifetime. The question is whether paying taxes on that money today makes more sense than paying them later.
Taking Advantage of Lower Tax Brackets
Think about a married couple who earned a substantial income throughout their careers. Once they retire, their taxable income may drop considerably, especially if they haven't started collecting Social Security and are still several years away from required minimum distributions. For a time, they could find themselves in a lower tax bracket than they were while working—or than they may face later in retirement.
Rather than converting their entire traditional IRA at once, they might convert a portion each year. For example, a couple in the 22% federal income tax bracket might convert enough to use the remaining room in that bracket without pushing a significant amount of income into the next one. Repeating that strategy over several years could move a substantial portion of their retirement savings into Roth accounts at tax rates they find attractive.
But being in a lower tax bracket today doesn't necessarily mean a Roth conversion is the right move. The real question is whether paying taxes on the conversion today will reduce your overall tax burden in the years ahead.
Reducing Future Taxes for You and Your Family
Another good reason to consider converting traditional retirement assets to Roth accounts is to reduce future required minimum distributions. Traditional IRAs and many other retirement accounts eventually require you to withdraw money every year, whether you need it or not. And those withdrawals are generally taxable. For people with substantial retirement savings, RMDs can become surprisingly large, especially when combined with Social Security, pensions, and investment income.
Converting some of those assets to Roth IRAs before RMDs begin reduces the amount that will eventually be subject to required distributions. This can help keep taxable income more manageable later in retirement while giving you greater flexibility over which accounts to draw from. You're not eliminating taxes, but you may be choosing to pay them at a more favorable time.
Married couples should also pay particular attention to this strategy. When one spouse dies, the surviving spouse typically files as a single individual. That's significant because federal income tax brackets for single filers are considerably narrower than those for married couples filing jointly.
Here's the problem: household income often doesn't fall nearly as much as those tax brackets do. Investment income may stay about the same, RMDs may continue, and the surviving spouse generally keeps the higher of the couple's two Social Security benefits, not both. As a result, someone can end up paying a higher tax rate despite having less household income. This is sometimes called the widow's or widower's tax penalty.
Converting some retirement savings to a Roth IRA while both spouses are alive can reduce future taxes and give the surviving spouse more flexibility to manage taxable income. For couples with substantial retirement savings, this is an often-overlooked benefit.
Roth conversions can also benefit the next generation. While heirs generally pay income taxes on distributions from inherited traditional IRAs, withdrawals from inherited Roth IRAs are generally tax-free. That's particularly valuable for adult children who may be required to withdraw inherited retirement savings within 10 years, potentially during their highest-earning years.
Moving to a Lower-Tax State? Timing Matters
Moving to a state with lower income taxes can make Roth conversions even more attractive. Florida is a good example because it has no state personal income tax, but the same opportunity may exist in other states with low- or no-income taxes.
Suppose you're planning to retire in Florida after spending your career in a state with higher income taxes. If you complete a large Roth conversion before moving, you could owe state income taxes that might have been avoided by waiting until after you've established Florida residency.
Of course, establishing residency isn't as simple as buying a house or changing your driver's license. States have their own residency rules, and the timing of a move needs to be coordinated with any planned conversion. If relocating is already part of your retirement plans, it makes sense to consider your Roth conversion strategy at the same time.
How Roth Conversions Affect Medicare Premiums
One potential catch is Medicare premiums. Medicare has an income-based surcharge called IRMAA, or Income-Related Monthly Adjustment Amount. If your income exceeds certain thresholds, you may pay higher premiums for Medicare Parts B and D. Because Medicare generally uses income from two years earlier, a large Roth conversion today could lead to higher premiums two years from now.
Does that mean you should avoid converting? Not necessarily. Higher Medicare premiums may be a worthwhile trade-off for long-term tax savings. And because Medicare recalculates these premiums annually, they can come back down when income falls, generally with a two-year delay. The important thing is to account for those additional costs when evaluating a conversion.
How Much Should You Convert?
Determining the right size for a Roth conversion is just as important as deciding whether to convert in the first place. The goal isn't necessarily to convert as much as possible, but to find an amount that makes sense given your current tax situation, expected future income, and overall retirement plan.
Ideally, you want to take advantage of years when your tax rate is relatively low, particularly if you expect it to rise later in retirement. It also helps to have money outside your retirement accounts available to pay the conversion taxes, so you don't have to reduce the amount going into the Roth or dip into funds needed for living expenses.
Nobody knows exactly what tax rates will look like 10 or 20 years from now. That's why it makes sense to consider several possible outcomes rather than betting on a single prediction. For some retirees, gradually converting portions of their traditional retirement savings over several years may be a smart move. For others, the upfront tax cost may outweigh the long-term benefits.
The years between retirement and required minimum distributions can create valuable tax-planning opportunities. But Roth conversions shouldn't be a one-time decision. A sound strategy considers the long-term benefits while reevaluating each year how much, if anything, makes sense to convert as your income, tax situation, and retirement plans evolve.
At Parks Wealth Partners, we help individuals and couples evaluate Roth conversions as part of their broader retirement income strategy, working alongside their tax professionals to weigh the immediate costs against the potential long-term benefits. If you're approaching retirement or considering a move to a lower-tax state, it's worth exploring whether Roth conversions should be part of your plan.