Does it make sense to convert your IRA to Roth in Retirement?
Posted on February 9, 2024
I subscribe to a stock market newsletter. This month it had an article with the same title as this post, Does it make sense to convert your IRA to Roth in Retirement? I found the article confusing and incorrect. The decision on Roth conversion is pretty simple. I’ve written on this before (here and here), but I think this post gives a shorter, clearer explanation: it makes most sense to me to convert if you avoid paying taxes in a significantly higher marginal tax bracket in the future or if you can avoid a Medicare premium surcharge; you avoid paying taxes you do not need to pay; will have more after taxes than you otherwise would. This applies to few retirees.
If you don’t see that converting to Roth now avoid higher taxes in the future, you have no reason to convert. You get the same after tax return from a Roth IRA and a Traditional IRA. And it is painful now to convert: you are paying more in taxes; you’ll have less than you would otherwise to spend to enjoy now. You have to see real benefits to convert.
== It NEVER really hurts ==
It NEVER hurts to convert from traditional IRA to Roth. You could win with a conversion, but you can ever lose. I can’t construct a scenario where a retiree winds up with less after taxes from a conversion. (I’m not counting doing something illogical, like converting a large amount of traditional at a high marginal tax rate only to be in a lower marginal tax bracket later.)
== Details: three cases ==
It makes most sense to convert some traditional IRA to Roth in three instances for a small set retirees.
1) Convert if you are now in the 12% marginal tax bracket and think you will pay the 22% marginal tax bracket in the future. This might apply to a small set of retirees and near retirees, and it takes a lot of planning to benefit: folks in this situation may not have a lot of headroom to keep the conversion amount in the 12% marginal bracket: the top of the 12% tax bracket for a single taxpayer is about $63,000 gross ordinary income for 2024: double that for joint, married filers. If they’re in the 12% bracket, they can’t convert large amounts in any year and stay in the 12% bracket.
2) A subset of retires with high income – some of the top 10% of all retirees – might want to convert to have flexibility to avoid Medicare Premium surcharges. They can convert and lower future RMD; they an withdraw from their Roth for their spending in the future and not increase taxable income that can trigger a Medicare Premium surcharge.
3) Married, joint filers with high income might want to convert even at the 24% marginal tax bracket to avoid the 32% marginal tax bracket that the surviving spouse would pay as a single filer.
== Biggest benefit: about 12% more ==
The biggest benefit is that you would have about 10% more in the future from a conversion to Roth. The best case is that you are in the 12% tax bracket now, but think you will be consistently be in the 22% tax bracket in the future – perhaps after your RMD starts.
It makes sense to convert the amount from traditional to Roth that still keeps you in the 12% marginal bracket. You pay the 12% tax now and not the 22% tax later. You will keep about 13% more after taxes on the amount you converted. (If your heirs are in the 22% tax bracket when they withdraw from Roth, they’re getting this 13% benefit.)
== Other jumps in tax bracket ===
This same math applies to other jumps in tax brackets, but only one other jump gets close to the benefit of the 12% to 22% bracket. Folks in these brackets have very high income. You also have to think through: if you convert at 22% bracket and hold Roth at death, will your beneficiaries be in the 22% bracket when they withdraw?
== Two other cases that make sense ==
Those with high income should consider two cases where conversion makes sense: avoid paying taxes that you do not need to pay.
• Convert some to Roth to give yourself flexibility to avoid Medicare premium surcharges. (I consider the surcharges as added taxes.) If you are near a tripwire in income that triggers a surcharge, you’d use Roth for your spending and not added withdrawals from traditional IRAs or from security sales in your taxable account .
• Married, joint filers with more than about $200,000 of ordinary income, should decide if they want to convert now to avoid the 32% marginal tax bracket when just one will be alive.
(You can read more here if you are at this level of income.)
Conclusion. Converting traditional to Roth NEVER hurts in retirement. I can’t construct a scenario where you would wind up with less after taxes if you convert. But it does hurt to pay taxes now rather than then. You only want to convert if you see real benefits.
Converting to Roth will give you more after taxes in the future in two cases:
1) if you can see that you (or the surviving spouse of the two of you) will be in a significantly higher marginal tax bracket in the future. (I’d say at least 8 percentage points higher.)
2) if you have high income subject to Medicare premium surcharges, Roth gives you flexibility in a future year to keep your income below a level that triggers a surcharge.