We all have a silent business partner. His name is Uncle Sam. He requests that you buy him out before you take your money home. He gets a bad rap, but he’s not a bad guy. Let’s just make sure we’re not paying above FMV. Roth IRAs can be a useful tool.
The Roth Conversion has become a popular strategy and here is one of many ways that is useful for both young high-income earners and retirees.
Fill Up That Tax Bracket. By converting some of your tax deferred savings (i.e. Traditional IRA) to a Roth IRA, you’re electing to pay taxes now for the right to live tax free later. Annually, consider accelerating your income by means of a Roth Conversion (and pay taxes) to the top of your existing bracket. This strengthens your hand in the case of:
- Higher tax rates during distribution years from taxable accounts (distribution could be younger than you think – keep reading).
- Reduces risk of increasing your tax bracket once you’re in Required Minimum Distribution territory.
For general guidance, see the illustration below from industry leader, Michael Kitces.
Young High-Income Earner. While this strategy seems to be mostly spoken of amongst people between the ages of 59 ½ – 70, younger people should consider this as well. Earnings in a Roth require an age of 59 ½ before distribution (few exceptions) – which is why the chatter for this strategy reaches the retiree crowd best. However, conversion dollars do not carry the age restriction, but merely a 5-year time horizon. In theory, you could convert a $1m Traditional IRA to a Roth at the age of 35 and five years later, take principal and conversion distributions tax-free. Not a suggestion, just an illustration.
Is it that crazy, though?
What if you are mid-late 30s, make around $500k per year, and have diligently saved to your pre-tax 401k. You decide to change employers after a great 10-15 year run. After making a good living, you have enough saved to take some time off and recalibrate, as well. Consequently, your tax bracket is extremely low for a year. What if you converted a $450k pre-tax 401k to a Roth IRA? You’d never pay less in taxes on the move because of your year in sabbatical. Presumably, you’d be in the lowest bracket. Wait five years and most of that money is yours tax-free. Wait until 59 ½ and ALL of it is tax free. That’s a $100,000 Decision.
While a drastic example that’s applicable to very few, it might help spur some thought to the possibilities in your unique situation.
Pre-retiree/Early Retiree. Consider that tax rates are historically low, and a reversion of some degree is pending in 2026 (the length of our existing tax law), particularly on the individual side.
Most people electing to ‘top off their tax bracket’ choose to do some variation of dollar cost averaging at a low level throughout the year in the form of Roth Conversions. By year end, when they have a better feel for cash flow and their precise income level, make a larger conversion to ‘fill’ their tax bracket.
Yes, they pay more in taxes currently. However, if you anticipate any sort of tax increase over the duration of your lifetime (particularly as modern-day retirements become 20-30 year plans), you owe it to yourself to explore. Run the numbers, or please, ask for help. Much like when to file for Social Security, this is a decision that may not feel like a huge pay increase for you in one single year, but over the duration of an entire retirement, it’s a 6-figure decision. Not to mention all conversions are immediately available to you tax-free after age 59 ½; you don’t have the 5-year waiting period like the group above.
Understanding what conversions might mean for you in concept is the most important, particularly over a 30-year period. A blog post isn’t an appropriate venue to spreadsheet a hypothetical, as the inputs are too presumptive (I tried, but felt inauthentic). That said, I encourage you to explore the concept and find a professional to assist with implementation.
I maintain that people’s angst with taxes revolves are two things: 1) They feel their dollars are inefficiently used and 2) They don’t understand taxes and don’t feel in control. Well, this is partially addressing point 2: Consider filling up that bracket now for more take-home pay later, and make Uncle Sam happy along the way.
Stay calm. Stay invested.
Thanks for reading,