Here are Practical Reasons for Partial, Annual Roth IRA Conversions. We have already highlighted to you IRA versus Roth IRA. What You Need to Know. Now we want to discuss why some investors should consider partial, annual Roth IRA conversions.
A Roth Conversion
A Roth conversion is when funds are distributed from a Traditional Individual Retirement Arrangement (“IRA”). They are taxed in the year of the distribution. Then the funds are converted or put into a Roth IRA.
One of the keys to doing a Roth IRA conversion is to have funds from another source to pay the income taxes. For example, you want to convert $20,000 from your IRA to a Roth IRA. Assume your federal income tax rate is 22% and your Connecticut income tax rate is 5%. It would cost you $5,400 of income taxes ($20,000 x 27% = $5,400.) You would need to have funds from another source to pay the taxes to convert the full $20,000. See IRS Publication 590-B – Distributions from IRA’s.
A Roth IRA Conversion is Very Counterintuitive
We are highlighting a partial, annual Roth IRA conversion here. Partial here means you will convert a portion of your IRA, not all of it. You and your CPA will determine the amount annually depending on your income tax bracket. In this context, annual means you plan to do a to do a partial Roth IRA conversion each year for a certain number of years, even though you are not required to. Remember, you can change your mind and your plan.
When recommending investors consider partial, annual Roth IRA conversions, initially, many folks will look at me like I have two heads.
“Wait, you want me to accelerate paying my income taxes?
Why would I EVER want to do that?”
Fair enough questions. Many of us grew up hearing the same mantra repeatedly. Defer your income and defer your income taxes.
I am not suggesting you should not defer a portion of your income. The most common tool to do this is through your employer sponsored 401(k) plan. In 2024, the average employee contribution was $8,800. The total employee contributions for 2024 were $528 billon with the total 401(k) plans value at the end of 2024 was about $8.9 trillion. 1)
That is a lot of deferred income and deferred income taxes.
Required Minimum Distribution (RMD) is Payback Time
Currently, taxpayers must start taking their Required Minimum Distribution (RMD) at age 73. The RMD age will increase to age 75 starting on January 1, 2033.
The amount of the RMD is based on your age and the prior December 31st value of the IRA. Investors with traditional 401(k) plans are currently also subject to the RMD at age 73 unless you are still working and are not a 5% of the business sponsoring the plan. The RMD starts out at about 4% of the value. This percentage increases over time as it is based on a life expectancy table.
RMD’s are Taxed as Ordinary Income
You pay ordinary income tax on RMD’s. This means you pay your income taxes at whatever marginal tax bracket you are in that year. RMD’s are not eligible for the preferred, lower capital gains tax rates. Capital assets held for more than a year, pay income taxes at lower, long term capital gains tax rates. The federal income tax rates are 0% for lower income, 15% for middle income and 20% for higher income taxpayers.
Here are some other sources of income tax are subject to ordinary income tax rates:
• Pension Income
• 401(k) Distributions
• Social Security Benefits (up to 85% of the benefits are taxable)
Layer RMD’s on top of this and, well, that is a lot of ordinary income. Possibly pushing you into a higher marginal income tax bracket.
Reasons to Consider Partial, Annual Roth IRA Conversions
If you are asset heavy and income light, consider making partial, annual Roth IRA conversions each year. In other words, you have significant financial assets but fall into a low-income tax bracket. For 2025 the federal income tax brackets start at 10% and go up to 37%.
The objective here for investors in more modest income tax brackets, would be to fill up your current income tax bracket. For example, if you are married filing jointly and earn up to $150,000, you can convert up to about another $56,000 into a Roth IRA and stay within the 22% federal income tax bracket. As stated earlier, you would want to have funds from another source to pay the income taxes so as you can convert the entire amount.
Another group that should consider partial, annual Roth IRA conversions are freaking old people (FOP’s). I can only say that because, well, I am one of them, and they are everywhere. Also, that age group is growing like crazy.
Over 11,000 people a day turn age 65 in the United States in 2025.
This is the “Peak 65”, as the number of folks turning age 65 a day will slowly begin to decline.
FOP’s may be candidates for partial, annual Roth IRA conversions as they may be ‘asset heavy and income light’ crowd mentioned above. Additionally, hopefully they have paid off their mortgage and have monthly excess cash flow. You could use this to pay the income taxes on the Roth IRA conversion.
Income Tax Projection
Work closely with your CPA and ask then to run an income tax projection. You want to take full advantage of income being taxed at a lower tax bracket. At the same time, avoid converting so much to a Roth IRA IRA that will push you into a higher marginal income tax bracket.
Also, request that your CPA have your tax game plan done by the beginning of December. Custodians are remarkably busy at year end. You want meet with your financial advisor and have all your paperwork done and be in the queue with your custodian so as you can complete your Roth IRA conversion timely.
Benefits of Contributing to a Roth IRA
While we are discussing partial, annual Roth IRA conversions here, it is also important to understand the benefits of contributing to a Roth IRA. Here are 3 Easy Reasons to Open a Roth IRA.
The first benefit of a Roth IRA is that you have already paid the taxes upfront. If you meet two very straightforward criteria:
Then all the distributions are income tax free.
The first criteria are that the Roth IRA must be open for at least 5 years. The 5-year period starts on January 1st of the tax year of the first year you made your first contribution. Not the date you make the actual contribution. The second is that you do not take any distributions until you are over age 59 ½.
That. Is. It.
Meet these two straightforward criteria, and all your distributions are tax free.
No RMD’s
The second benefit is that unlike Traditional IRA’s and 401(k) ‘s, Roth IRAs are not subject to the RMD’s mentioned above. This means that the account holder and their surviving spouse are not required to take any RMD’s from their Roth IRAs during their lifetime. As the account holder and the surviving spouse do not need to take RMD’s during their lifetime. This extends the runway. The funds in the Roth IRA continue to grow tax free.
For Average Joes, if they listen to their doctor and Diet and Exercise, they should spend a long time in retirement. For example, a married couple, both age 65, the wife has a life expectancy of age 86. The Roth IRA could potentially grow for another 21 years or more before you must being taking the the RMD required.
A non-spousal beneficiary, like a child or grandchild, must take distributions from the Roth IRA only when they inherit it.
If a child or grandchild inherits the Roth IRA, they can take distributions whenever they want. However, they must withdraw all of the funds by the end of the tenth year. If the original account holder kept the account open for at least 5 years, the beneficiaries can take all distributions income tax free.
You can see, for the age 65 parents referenced above, between their life expectancy and the non-spousal beneficiary RMD requirements, the Roth IRA funds could grow for another 30 years tax free.
That is Awesome!
Four Key Planning Points
1) Considering Moving to a State That Does Not have a State Income Tax?
If you are considering partial, annual Roth IRA conversions and you are also considering moving to a state that does not have an income tax, you may want to hold off on the Roth IRA conversion. Currently, there are nine states that do not have a state income tax. In Connecticut, our experience is that folks that move to a state that does not have an income tax, typically move to Florida or New Hampshire.
Back when I was a practicing CPA, we had a client that was a Connecticut resident and had a second home in Florida. We started discussing the benefits of a partial, annual Roth IRA conversion. Then I asked them if they would ever consider becoming Florida residents. The benefit of being a Florida resident as opposed to a Connecticut resident is that Florida does not have an income tax or an estate tax.
They indicated they were strongly considering becoming Florida residents. That is when I suggested we put the partial, annual Roth IRA conversion on the back burner until they became Florida residents. We did not want them to have to pay Connecticut state income tax of about 6% on the Roth IRA conversion. Once they became Florida residents, we began our plan of partial, annual Roth IRA conversions. They have done this now for over half a dozen years.
2) Collecting Social Security Benefits
If you are collecting your Social Security benefits and are considering a partial, annual Roth IRA conversion, be cautions.
If your income rises above a certain threshold, your Medicare Part B, medical insurance, and Part D, prescription drug coverage will increase. This charge is known as the Income-Related Monthly Adjustment Amount (IRMMA).
The IRMMA looks back to your income tax return from two years ago. In 2025, they would be looking at your 2023 income tax return. If you were subject to IRMMA in 2023, they will notify you in the fall of 2024. The increase in premiums would start in and run through the calendar year of 2025. Therein lies the rub. Not too many people are familiar with IRMMA. Until they are. Then their Social Security check starts getting reduced in about 60 days. For an entire year. Ouch.
When your Modified Adjusted Gross Income (MAGI) goes above $206,000 IRMMA starts to kick in. The monthly premium increase adjustment starts at about $74 and for higher income taxpayers goes all the way up to $510.
If you are collecting Social Security benefits, make sure your CPA calculates any potential IRMMA additional premiums that may be due to a potential Roth IRA conversion.
3) All Partial, Annual Roth IRA Conversions Have Their Own 5-Year Clock
If you are making partial, annual Roth IRA conversions, be aware that each annual conversion has its own 5-year clock.
This is different from contributing to a Roth IRA. When you contribute to a Roth IRA, the 5-year clock starts running the year of your first Roth IRA contribution. There is no subsequent 5-year clock for any Roth IRA contributions made after this.
4) You May Have to Pay Estimated Taxes
As mentioned above, when doing a partial, annual Roth IRA conversion, income taxes will be due on this. One thing you want to avoid having to pay an income tax penalty for underpayment of estimated taxes.
The U.S. income tax system is pay as you go. This is not an issue for employees that work at a company. Their income taxes are withheld from their paycheck throughout the year. This could work out to a modest refund or balance due the following spring when they file their income tax return.
Doing a partial, annual Roth IRA conversion will increase your taxable income and your income taxes. As the goal is to convert the entire amount of the IRA distribution, the income taxes will need to be paid by either increasing your withholding or paying estimated income taxes.
Here is how to avoid the penalty. If your Adjusted Gross Income (AGI) was less than $150,000 for the prior year, make sure you have paid in at least 100% of your prior year income tax. If your AGI was $150,000 or more for the prior year, have paid in 110% of your prior year income tax.
As a practical matter, many partial, annual Roth IRA conversions are done in the fourth quarter of the year. This makes it somewhat easier for the CPA to do a reasonably accurate income tax projection.
Having said that, it might be difficult to have your withholding adjusted in time to cover your income tax obligation. Therefore, you should make an estimated tax payment. The fourth quarter estimate is due by January 15th of the following year.
Action Item
If you would like help with Practical Reasons for Partial, Annual Roth IRA Conversions give Thomas F. Scanlon a call at (860) 645-1515 or E-Mail Thomas.scanlon@raymondjames.com
This is original content written by Manchester, CT Financial Advisor, Thomas Scanlon, CFP®, CPA.
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