For many high-net-worth retirees, Roth conversions present a compelling tax-saving opportunity. Over the course of your retirement, a well-planned Roth conversion strategy can save you six or even seven figures in taxes. But the real question is: when do you actually realize those savings?
If you’re considering Roth conversions, it’s critical to understand not just the total tax savings but also the timing of those savings. Do the benefits materialize early in retirement when you can fully enjoy them, or do they show up decades later when the impact may be less meaningful? Today, we’ll walk through an example to illustrate this concept and help you make informed decisions about your retirement tax strategy.
Understanding Roth Conversion Benefits Through a Real-World Scenario
To better grasp the impact of Roth conversions, let’s examine the case of Luke and Mary, a couple planning for retirement. Luke is 61, and Mary is 58. They have $4 million in total investments, most of which are in pre-tax accounts like IRAs and 401(k)s. They also have a small Roth IRA and nearly $1 million in a taxable brokerage account.
Their plan is to work for a few more years—until Luke is 63 and Mary is 60—before retiring. At that point, they’ll start drawing from their assets to fund their lifestyle. However, their investments will continue to grow, and without a tax strategy in place, they could end up paying significantly more in taxes over time.
The Roth Conversion Strategy: How It Works
The goal of a Roth conversion strategy is to intentionally move pre-tax assets into Roth accounts at lower tax rates today to avoid higher taxes later. This is particularly important for individuals with large IRA balances, as required minimum distributions (RMDs) can push them into much higher tax brackets in later years.
For Luke and Mary, we identified a strategy where they systematically convert a portion of their pre-tax accounts into Roth IRAs while keeping their taxable income within the 22% federal tax bracket. By doing this until Luke turns 72, they could significantly reduce their lifetime tax burden.
The projected benefits of this strategy are significant:
- $3.3 million more in tax-adjusted ending assets
- $3 million less in total taxes paid over their lifetime
- Nearly $6 million fewer in required withdrawals from their traditional IRAs
Clearly, this strategy has the potential to create enormous tax savings. But when do they actually feel the impact of these savings?
The Break-Even Point: When Do Roth Conversions Pay Off?
One of the biggest concerns retirees have about Roth conversions is the break-even point—the moment when the upfront tax costs of converting are offset by the future tax savings.
At first glance, the break-even point in Luke and Mary’s plan appears to be very late in life—around age 95 for Luke and age 92 for Mary. That might make the strategy seem less appealing. After all, why pay taxes now if the benefits don’t show up until the final years of retirement?
However, this is the wrong way to evaluate Roth conversions. Many people focus solely on when the total dollar amounts match up, rather than considering the tax-adjusted value of their accounts.
The Right Way to Measure Roth Conversion Success
Instead of just looking at total dollar amounts, you need to consider how much of your money is truly yours after taxes.
Let’s say you’re given the choice between:
- $1 million in a traditional IRA (which is fully taxable)
- $1 million in a Roth IRA (which is tax-free)
The obvious choice is the Roth IRA. But what if the options were $1 million in a traditional IRA or $900,000 in a Roth IRA? In that case, the right choice depends on your future tax rate. If you expect to be in a 25% tax bracket, the $900,000 in a Roth IRA is actually worth more than the $1 million in a traditional IRA because you don’t have to pay taxes when you withdraw it.
This is exactly why Luke and Mary’s break-even point isn’t actually at age 95—it’s much sooner when we look at tax-adjusted asset values. By converting now, they lock in lower tax rates and protect themselves from the risk of higher taxes in the future.
The True Value of Roth Conversions
The real benefit of a Roth conversion strategy is not just about hitting a break-even point—it’s about tax diversification and control. By moving assets into Roth accounts while in a lower tax bracket, you gain:
- Lower lifetime taxes by avoiding future higher tax rates
- More flexibility in retirement withdrawals, allowing you to control your taxable income in later years
- Reduced impact of RMDs, which can push you into higher tax brackets if left unchecked
- Better estate planning opportunities, as Roth IRAs can be inherited tax-free by your beneficiaries
For Luke and Mary, the key takeaway is that by using a Roth conversion strategy wisely, they can benefit much sooner than it appears at first glance. Instead of waiting decades to see the value, they are improving their tax-adjusted net worth immediately by locking in lower rates today.
Should You Consider Roth Conversions?
If you have significant assets in pre-tax retirement accounts and anticipate being in a higher tax bracket in the future, Roth conversions could be a game-changer for your retirement plan.
However, every situation is unique. Factors like your current and future income, withdrawal needs, Social Security timing, and estate planning goals all play a role in determining whether this strategy makes sense for you.
That’s why we recommend working with a financial planner who can model out different scenarios and help you determine the optimal Roth conversion strategy for your specific situation.
Final Thoughts
Roth conversions can provide massive tax savings, but only if they are implemented strategically. Rather than focusing on when the dollar amounts match up, consider the tax-adjusted value of your assets and how a Roth conversion can give you more financial freedom in retirement.
If you’re looking for a way to optimize your retirement tax strategy and maximize your after-tax wealth, let’s talk. Schedule a call with our team at Root Financial, and let’s build a plan that helps you keep more of what you’ve worked so hard for.