Is a Roth Conversion really worth it?
It's a question I encounter almost daily—whether on the internet, on YouTube, in podcasts, or even in the occasional email that lands in my inbox. Roth conversion chatter is everywhere. And that’s a good thing. Growing awareness of the potential power of Roth IRAs and Roth conversions is fantastic to see.
Industry experts across the board are weighing in, and for the most part, we all agree:
Roth conversions can be a powerful way to save on taxes.
Roth conversions shift assets to the tax-free side of the table.
Roth conversions aren’t for everyone.
Roth conversions require guidance from an expert who understands all the considerations involved.
Roth conversions can push you into a higher tax bracket in the conversion year.
Roth conversions might increase your IRMAA surcharges.
All true.
However, some recent comments from sources I usually trust have given me pause:
"A taxpayer uncertain about future tax rates might want to think twice before converting."
"Most people will have lower incomes in retirement, so they might be better off with traditional IRAs."
"One of the biggest mistakes in a Roth conversion is not fully accounting for the immediate tax impact."
"IRMAA surcharges can erode the benefits of a Roth conversion."
"Your tax bracket today is likely higher than it will be in retirement."
"Only convert up to the top of your current tax bracket."
I think I’ll stop there. Let’s discuss.
For most people, the number one objection to a Roth conversion is paying those taxes upfront. I get it. The tax bill can seem large, especially when a client goes to scratch that check.
But I encourage everyone to look at those taxes through a different lens - and more specifically, to look at that IRA statement through a different lens.
Take a look at the statement above for a traditional IRA. When your client opens up that envelope and reads the statement, they see that account value. And they believe all of that money is theirs.
And now look at the statement above for a Roth IRA. Similarly, when your client opens up that envelope and reads the statement, they see that account value. And they believe all of that money is theirs.
The problem is that one of those statements is an illusion. It’s not intentional, but one of these statements is misleading.
Imagine if there was one more thing added to the statement: A line item for taxes owed if your client withdrew that money.
Now how does the Traditional IRA statement look compared to the Roth IRA statement?
The most relevant number on an IRA statement isn’t the account’s total value; it’s the after-tax value. When you consider that, the value of a traditional IRA and a Roth IRA are essentially the same. In other words, “paying the tax” during a Roth conversion is simply giving the IRS its share upfront.
Think of it like borrowing your wealthy uncle’s Ferrari—it’s a thrill to drive, but it’s not truly yours. At the end of the day, it goes back to his garage, not yours.
I can already hear the objections: “But what about the growth and compounding on the untaxed money left in the IRA? Won’t that lead to a higher value down the road?”
Let’s revisit those statements. This time, we’ll project a 5% growth rate over the next 10 years.
And here we are again, looking through the pre-tax lens and falling for the illusion. At first glance, it might seem like the IRA is better off—after all, it benefits from all that compounding. The IRA has to be the winner, right? But we know better. We know we need to focus on the after-tax value.
And not so fast- we’re actually at the exact same value. If tax rates and growth rates are the same in each scenario, then you are going to get the same after-tax value for each.
So now, let’s make one simple yet powerful change to the example. Let’s assume taxes change by the time the client starts taking income. Isn’t that the risk we are trying to mitigate when considering Roth conversions? Let’s assume taxes go back to levels we saw a few decades ago. Let’s assume the effective tax rate is now 26%. How much does that change the example?
And lo and behold, we’re no longer at the same value. With a higher tax rate in the future, after the Roth Conversion takes place, then you are going to see a dramatically different after-tax number for the account forced to pay taxes in that new, higher environment.
And this is why we convert. To avoid those higher taxes down the road. In this case, about $50,000 in higher taxes.
So, can we finally set aside the notion of “paying taxes” as a serious objection to a Roth conversion? I hope so.
The real question to ask is the actual cost of those taxes. That’s the part where planning is crucial.
Two important concerns are sometimes cited as a reason not to convert: “Tax Drift” and IRMAA Impact.
But we need to ask the questions: when it comes to a dollar and cents analysis of Roth conversions, should we always avoid tax drift? Should we always avoid having to pay additional IRMAA surcharges during a conversion?
Some may say yes. In fact, most of the talking heads in our industry will say yes. On the surface, it would be tough to defend a plan that pushed a client into higher tax and/or IRMAA surcharge brackets.
But I’d argue that for some clients, it might actually make sense to do the unthinkable: absorb a bit of tax drift and even some extra IRMAA surcharges. Why? Because once the conversion is complete, there will be no further taxes on that money—and no more IRMAA surcharges. In a sense, we’re “buying out” the IRS at today’s rates to avoid potentially higher taxes and fees in the future.
Of course, the math has to check out. So, that’s why it's important for advisors to understand how to fully evaluate Roth conversions of their clients, and how to choose a conversion period that makes the most sense for a client’s specific situation.
And that’s what’s missing when I listen to a lot of the talking heads in our industry. I’ve read a lot of articles. I’ve listened to a lot of podcasts. I’ve even watched some terrible YouTube videos. And not once have I heard the most important factor of a Roth Conversion discussed.
What’s missing from the conversation? The fact that the rules can change.
Everyone talks about the current rules and assumes those current rules apply to all future scenarios.
But as we know, the rules around government taxes, fees, and regulations are constantly changing.
Let’s look at how some of the rules we have today could potentially change for our clients.
First, let’s look at the potential for rule changes in the tax code, which can lead to rising taxes. Let’s say, for example, we plan to convert IRA assets over a 10-year time frame. And tax policy changes in the 6th year of the plan making taxes higher for all Americans in the process (for example, tax brackets are adjusted, or new taxes are implemented). In that case, would it have been nice to have converted our IRA money to Roth before that tax policy change happened? The short answer is yes.
The possibility of tax policy changes - not to mention changes to government fee levels, like IRMAA - is a huge factor in determining not only whether to convert your IRA assets to Roth, but also how quickly. And this possibility, of higher taxes during your planned conversion period is a major reason to accelerate your conversion pattern. Even if it potentially means absorbing some tax and IRMAA surcharge drift today.
To me, ultimately, this is the main reason to convert a portion of your IRA money. Because the rules can change. Rule changes create uncertainty. Uncertainty creates risk. And when dealing with my retirement assets, I want to reduce risk.
The simple fact is that rules could change. That tax rates could change. That I could pay more taxes in retirement than today. Not because of my personal situation. Not because of my tax bracket. But because the tax situation around me changed.
This is a complete approach to risk mitigation. Consider it the same reason I use asset allocation to mitigate changes that can happen in the market. It’s the same reason I use longevity protection to protect against the fact that I could live longer than planned.
Doing a Roth conversion introduces certainty to those assets because I no longer have to worry about future changes to taxes and IRMAA fees. I like certainty when it comes to my retirement money. And many of your clients do, too.
So, as we’re evaluating Roth conversions for our clients, remember we need to prepare not just for the realities of today, but for future risks. Eliminating the impact of potential tax-rule changes is a key component of the decision to convert. And our industry’s most sophisticated - and successful - advisors will want to help their clients understand why. If you want a deeper dive into Roth conversions, watch our most recent study group webinar here.