Would you like to pay more income tax this year? It might not be as crazy as it sounds.

Roth conversions – the process of moving money from a pre-tax retirement account to a tax-free Roth alternative – can be a powerful retirement income planning and tax planning tool. But it likely means pulling income from the future to the present, along with any associated income tax.

First, here is a quick look at why so many investors are considering Roth conversions.

As pension plans and other defined benefit plans have waned in popularity, defined contribution plans – those where the employee is responsible for saving and investing retirement dollars – have become the norm. When it comes to retirement savings, the timeline below includes a few of the important milestones from the last 50 years.

The 401(k) has become one of the primary ways Americans save for retirement. According to the Investment Company Institute, 401(k) plans held $7.4 trillion in assets at the end of last year. Another $6.8 trillion had been rolled out of employer-sponsored retirement plans – like 401(k)s - and into IRAs. That’s a lot of dough.

Before 2006, 401(k) contributions could only be made with pre-tax dollars. At some point, those traditional IRA and 401(k) assets will be taxed. Withdrawals are considered ordinary income, taxed in the year of the withdrawal, at whatever tax rates are at the time of the withdrawal.

Enter Roth conversions. Roth conversions are taxed in the year of the conversion as well.

So, the question many of us face is: complete a Roth conversion and pay tax now, or keep the money in a pre-tax account and pay tax later?

Here are a few potential reasons you may consider a Roth conversion.

Pay a “known” tax rate.

At the end of 2025, the reduced tax rates introduced by the Tax Cuts and Jobs Act (TJCA) are scheduled to revert to their previous rates. If you believe tax rates will rise in the future – and there are certainly reasons to think that could be the case – a Roth conversion effectively “locks in” current tax rates on those converted dollars.

The table below outlines the tax brackets for 2024, as well as our estimates for 2026.

The income ranges in the Expected Tax Brackets table are estimates, based on the annualized rate of inflation (consumer price index) between 2018 and July 2024, or 3.69% per year, and carried forward to 2026. Income thresholds, if TJCA expires, will be different.

In many cases, it could make a lot of sense to pull income into the 2024 and 2025 calendar years. Here are two examples. To keep these examples as simple as possible, I have not included state tax, Net Investment Income Tax, or other potential tax impacts from a Roth conversion.

Consider a family with taxable income of $350,000. They could convert $33,900 from a traditional IRA to a Roth in 2024 and owe $8,136 in federal income tax on that conversion. If they wait two years and the tax changes expire, they would likely be in the 33% tax bracket and owe an estimated $11,187.

A single filer with taxable income of $80,000 and a large pre-tax IRA may also want to consider a series of Roth conversions. They are likely to be in the 22% marginal tax bracket this year and next, and potentially moving to the 25% bracket in 2026 if TJCA expires at the end of 2025.

Make sure to consider your individual circumstances before converting. There are situations where marginal tax brackets are higher under TJCA, and Roth conversions cannot be undone. Many financial advisors (including us) use tax planning software to help with analyzing different scenarios, but you should also consider consulting your tax professional.

Limit future RMDs.

Pre-tax 401(k)s and IRAs are subject to required distributions at a certain age – RMDs. This is the government’s way of effectively saying, “You have deferred tax long enough. Time to pay.” Roth accounts are not subject to the same rules. Assets can remain in Roth IRAs indefinitely, continuing to grow tax-free.

Again, an example may help.

Consider a 60-year-old individual who retired with a large pre-tax 401(k). Between contributions, company match, and growth, the account is worth $2 million.

This has the potential to be a ticking tax bomb situation. Investors are required to take withdrawals from pre-tax IRAs and 401(k)s, starting at age 72, 73, or 75, depending on when they were born. These are called Required Minimum Distributions.

If the 401(k) grows at 6% per year and remains untouched – meaning it isn’t needed to support retirement spending – the investor could face significant Required Minimum Distributions (RMDs). Look at the chart below.

At age 75, the investor would need to withdraw nearly $200,000 to satisfy the RMD. That alone would likely be enough to push the investor into the 33% marginal tax bracket, assuming TJCA expires. At 85, the RMD is nearly $335,000.

All of that would be ordinary income.

Converting some of those pre-tax retirement assets today at 22% or 24% tax rates could potentially save thousands of dollars in lifetime taxes.

Tax flexibility in retirement.

This isn’t a mathematical argument, per se. The estimated tax brackets I provided above will almost certainly be inaccurate. While we cannot know what tax rates will be in the future, we can give ourselves options.

We often talk about having three unique tax buckets:

1) Taxable – the most common example is a brokerage account.

2) Tax-Deferred – this would include traditional IRAs, pre-tax 401(k)s, and many other employer sponsored retirement plans. Contributions are made with pre-tax dollars (or are tax deductible in the case of a traditional IRA), they grow tax-deferred, and distributions are considered ordinary income.

3) Tax-Free – the Roth IRA/401(k) is the most obvious example. These accounts are funded with after-tax dollars, grow tax-deferred, and, if the account has existed for at least five years and the owner is over 59½ years old, can be withdrawn tax free.

Each of these “buckets” can serve a purpose. Whether you have low income retirement years or high income years, having a meaningful amount in each category can provide the flexibility to have some control over taxes.

Legacy concerns

I hope we all enjoy life. Spend money on the things that bring us happiness. If, however, you don’t plan to spend all of your retirement assets and are thinking about the impact to future generations, ask yourself two questions:

Are your beneficiaries in substantially higher tax brackets than you?

Would you like to limit the amount of income tax paid across generations?

If you answered yes to both, it could be worthwhile to convert some pre-tax assets to a Roth account. High income individuals and families get the biggest benefit of tax-free growth.

Before you convert, words of caution

As I mentioned above, Roth conversions are final. There is no going back. So before you move forward with a conversion, here are some final considerations and rules of thumb.

Pay more out-of-pocket now. Converted dollars are taxable in the current year. It is usually wise to pay the extra tax with outside money, and not withhold from the IRA. It allows for more tax-free growth and avoids potential penalties for those under the age of 59½. Make sure you have access to liquid assets to pay the bill.

Pulling income forward can have other implications, beyond your tax bill. Are you on Medicare, or plan to enroll in the next two years? Medicare Part B and D premiums could rise if certain income thresholds are crossed. This is the income-related monthly adjustment amount, or IRMAA. Certain investment income could also be subject to the 3.8% Net Investment Income Tax if the Roth conversion pushes income over a certain level. For those individuals receiving Social Security retirement benefits, a Roth conversion could also impact the amount of those benefits that is subject to tax.

Summary

Roth conversions can be a powerful tool, especially with the looming expiration of current tax rates. By converting pre-tax retirement assets to a Roth account, you might secure lower tax rates now and reduce future tax burdens. However, the decision is not without risks, and it's important to weigh the immediate tax costs against the long-term benefits. Make sure to assess your individual circumstances and consult with a professional before proceeding.

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