Thoughts on Roth conversions

Steve Merrell |

Q: I am 64 years old and recently retired. My 401(k) plan is worth about $1 million and I have about $500,000 in taxable investments. I have been thinking about converting a portion of my retirement savings into a Roth IRA. Do you think a Roth conversion makes sense?

A: Before doing a Roth conversion you need to consider several factors. I can give you a few pointers here, but you really need to talk with a financial advisor who can run the numbers for your specific situation.

When you are dealing with traditional retirement accounts like traditional IRAs and 401(k) plans, you need to remember that every dollar in the account has a future tax liability associated with it. You will trigger the tax liability the moment you withdraw money from the retirement account.

Roth retirement accounts, on the other hand, are free of future tax liabilities. Any tax liabilities were satisfied at the time you contributed the money to the Roth. Therefore, a decision to do a Roth conversion is really a decision about when to realize the tax liability. Understanding this principle can help you recognize Roth conversion opportunities when they arise.

You may have such an opportunity. As a 64-year-old, you are not required to take any money from your retirement accounts, and you have a healthy balance in your taxable savings. To the degree you support your lifestyle with withdrawals from your taxable savings, you will report very little taxable income for the next couple of years. Even when you start taking social security, your taxable income will be relatively low and will likely put you in the lowest (12%) marginal tax bracket. To the extent you can keep your taxable income below $39,475 for a single taxpayer or $78,950 for a married-filing-jointly taxpayer, every marginal dollar of income you report will be taxed at the lowest rate.

When you start taking distributions from your 401(k) plan, you may find it difficult to keep your income level in the lowest tax bracket. At that point, the window of opportunity for Roth conversions may close.

A Roth conversion might also make sense when you believe the value of your portfolio is artificially or temporarily depressed. For example, let’s suppose the market goes through a severe downturn like it did in 2008. Converting to a Roth during such a downturn means your tax liability would also be lower. As the market recovers, so will the value of your Roth, but you will enjoy that market appreciation without having to worry about future taxes.

Roth conversions work best when you pay the taxes on the conversion with funds outside your traditional IRA. Keep in mind, also, that these Roth conversion opportunities come and go quickly depending on other circumstances in your life. The opportunity may not last very long, so you need to be ready to act when they appear. Finally, be careful. Under the new tax laws, Roth conversions are (mostly) irrevocable.

Q: My company recently added a Roth option to our 401k plan. We can now choose to contribute to the Roth or the traditional 401k. Which do you think is better?

A: I really like Roth 401(k) plans. However, there are a few things about them that you need to remember.

First, contributions to Roth 401(k) plans are made with after-tax dollars, so be prepared to see less take-home pay in your paycheck. Roth 401(k)s are especially powerful if you have the discipline to make the same contributions to the Roth option and you made to the traditional option.

Second, there are no income limits for a Roth 401(k). Roth IRAs, on the other hand, are unavailable for married-filing-jointly taxpayers with incomes greater than $203,000.

Finally, money in a Roth 401(k) is subject to required minimum distributions beginning the year you turn 70 ½. However, you can avoid the RMD on your Roth 401(k) by rolling it over to a Roth IRA when you retire. Roth IRAs do not have RMDs.



Steven C. Merrell  MBA, CFP®, AIF® is a Partner at Monterey Private Wealth, Inc., a Wealth Management Firm in Monterey.   He welcomes questions that you may have concerning investments, taxes, retirement, or estate planning.  Send your questions to: Steve Merrell, 2340 Garden Road Suite 202, Monterey, CA  93940 or email them to