Compare Roth conversion amounts, cash for taxes and income-sensitive costs before year-end. A partial conversion may fit better than the maximum.
December 2, 2024 · Financial Forte Staff
Historical article: prepared retrospectively using information available as of December 2, 2024.
A Roth conversion can look especially attractive near year-end, when there is still time to make a decision that affects this year's return. The opportunity is real, but the useful question is not how much you can convert. It is how much, if any, fits the full tax and cash-flow picture.
Compare several conversion amounts before sending an instruction. Consider the taxable portion, the marginal cost of each additional dollar, income-sensitive effects and the cash available to pay the tax. Future qualified Roth withdrawals can have value, but paying tax now does not guarantee a better lifetime outcome.[1][2]
Establish what would actually be taxable
A conversion moves eligible traditional IRA assets into a Roth IRA and generally includes the previously untaxed portion in income. If you have nondeductible IRA contributions or other basis, the taxable amount needs the appropriate calculation. You cannot ordinarily isolate after-tax dollars merely by choosing an account that contains them; the applicable IRA aggregation and reporting rules matter.[1][2]
A conversion is also different from an annual Roth IRA contribution. The contribution eligibility and annual limit should not be used as though they were a blanket conversion limit. Confirm the intended receiving account and verify the rules for the actual transaction, especially when money comes from an employer plan rather than an IRA.[1]
If an RMD applies, address it first with the custodian and tax advisor. The required amount is not eligible for conversion. Treat the RMD and any additional conversion as separate pieces of the distribution plan rather than assuming a transfer to the Roth satisfies both objectives.[1][2]
Gather the year-to-date income, planned deductions, capital gains and remaining distributions before estimating the conversion. A projection built from last year's return alone can miss a bonus, property sale or other event that changes the available room this year.
Compare the next increment rather than one average rate
Simone has an entirely pre-tax IRA in this hypothetical comparison. Her tax professional's simplified projection shows $20,000 of additional taxable income at an assumed 22% federal rate, with the next $20,000 at an assumed 24%. Those are illustrative marginal-rate assumptions, not quoted bracket thresholds or a complete tax return.
A $20,000 conversion would create $4,400 of federal tax under that model. A $40,000 conversion would create $4,400 on the first portion and $4,800 on the second, for $9,200 total. The second $20,000 costs more at the margin, even though the combined average rate is 23%.
That does not automatically make the larger conversion wrong. Simone may have reasons to accept the higher current cost, such as expected future taxable distributions or a preference for more tax diversification. But the reason should be tested against realistic alternatives, including smaller conversions over several years or no conversion now.
Future tax rates, investment results and spending needs are uncertain. Avoid a projection that presents one set of assumptions as a guaranteed tax saving. Compare what happens if the future rate is lower, similar or higher, and include the value of the money used to pay today's tax.
The five-year and other rules for Roth withdrawals also matter. Do not assume that every dollar converted can be spent immediately with identical tax consequences. Qualified distribution rules and conversion-related rules need to be reviewed for the person's age, account history and intended use.[2]
Include effects beyond the income-tax bracket
A conversion can increase income used in other calculations. For a Medicare beneficiary, for example, higher income can affect income-related Part B premiums. The standard determination generally uses tax information from two years earlier, subject to exceptions. A 2024 conversion therefore may have a later premium consequence rather than changing only the immediate tax bill.[3]
The future premium thresholds are not yet known. Ask for a range of possible outcomes and note which assumptions would change the conversion decision. Revisit those assumptions when the relevant figures are announced. Household filing status and other income can also affect the result.
Simone should ask her tax professional to identify other relevant income-sensitive items in her actual return. The complete marginal cost can differ from the bracket calculation alone. That is especially important when a relatively small additional conversion could cross a threshold affecting another cost or benefit.
Make the tax payment part of the decision
Simone has $12,000 of cash outside the IRA, but $5,000 is reserved for a planned repair. That leaves $7,000 potentially available for the conversion tax. The illustrated $20,000 conversion's $4,400 federal tax fits within that amount; the $40,000 conversion's $9,200 does not, even before state tax or other effects. The smaller conversion leaves $2,600 of that available cash; the larger one would be $2,200 short.
She could consider another funding source, change the conversion amount or decide against the transaction. Withholding tax from the IRA reduces the amount reaching the Roth and can create additional issues depending on age and circumstances. Compare the actual cash movement rather than assuming the entire gross withdrawal will become Roth savings.[1][2]
A conversion made after 2017 cannot be reversed by recharacterizing it back to a traditional IRA. That makes a careful projection and confirmation of the instruction particularly valuable.[1] For a direct year-end conversion, allow time for the institution's processing and verify the completed transaction and reporting year.
Begin with a current tax projection, a source for the tax payment and advice on any required withholding or estimated-payment timing. Then choose an amount for a reason you can explain in the context of future income, flexibility and available cash. A thoughtful partial conversion can be more useful than filling every available space simply because December is ending.
Related reading
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Educational information, not personalized investment, tax, legal or benefits advice. Examples use hypothetical assumptions. Verify current rules and your circumstances before acting.
