The Roth IRA conversion opportunity

If you’ve ever looked at a Roth IRA conversion and thought, “So I’m choosing to pay taxes now… so I can potentially pay less later?” – you’re exactly right. But that’s not the whole story.

Here’s the part many people miss: retirement isn’t the end of tax planning. In many ways, it’s when tax planning becomes more important – because once you retire, you often gain more control over your income. You can decide when to start Social Security, when to turn on a pension, when to realize capital gains, and – here’s the big one – when and how much to pull from your traditional IRA.

And that’s what makes the “golden window” such an opportunity.

What is the “golden window”?

Most people can take distributions from traditional IRAs without the early-withdrawal penalty beginning at age 59½. And starting at age 73, the IRS requires annual withdrawals called required minimum distributions (RMDs).

So, between 59½ and 73, you have a stretch of years where IRA withdrawals are largely on your terms. But the window I’m talking about is usually even more specific:

The golden window is the span of time between the year you retire and the year RMDs begin.

Example: retire at 65, RMDs begin at 73. That’s eight years where you may have lower income – especially if you haven’t started Social Security yet – and potentially a lower tax bracket. That can be a prime time to convert some of your traditional IRA dollars into Roth dollars.

Why convert before the IRS makes you?

Because RMDs can surprise people.

I’ve seen retirees reach their 70s only to discover their RMDs are larger than expected. They may be forced to pull out more than they need to live on, pay taxes at whatever bracket that creates, and then have to decide what to do with the rest. But once you’re taking RMDs, there’s one thing you can’t do with that money: You can’t move your RMD into a Roth IRA.

So instead of waiting for the IRS to dictate the pace, the golden window gives you a chance to be proactive – potentially reducing future RMDs and building tax-free dollars for the rest of your life.

The strategy: “fill the bracket”

One common approach is what tax professionals call “filling the bracket.” The concept is simple: estimate your taxable income for the year, then calculate how much room you have before you hit the next tax bracket. That number becomes a potential Roth conversion target.

Two important reminders:

1. Roth conversions are irreversible. Years ago, you could “undo” a conversion. Not anymore.

   
   

2. Realize, however, that if you do cross into a higher bracket, you’re not taxed at that rate on the entire conversion – only the portion that spills into the higher bracket.

   
   

A practical tactic: you can do more than one conversion per year. Some folks convert a portion earlier, then do a second conversion late in the year – when income estimates are clearer – to “top off” the bracket. Or you can simply wait until late in the year to make the move. Just don’t wait until the last minute in December, because custodians may not process conversions that are too close to the IRS’s year-end deadline.

A few mistakes to avoid

Before you convert, think beyond the tax bracket.

• How will you pay the tax? If you can, pay the taxes from a taxable account or cash reserves – not from the IRA itself – so the full converted amount lands in the Roth where it can potentially grow tax-free.

  
  

• Watch the ripple effects. Extra income from conversions can make more of your Social Security benefits taxable, trigger Medicare IRMAA surcharges, or reduce tax deductions. Coordinate with your tax advisor so there are no surprises.

  
  

• Don’t ignore market pullbacks. Bear markets are unpleasant – but they can create opportunity. If your IRA drops in value, you’ll be able to convert a larger percentage of the account with the same tax impact.

  
  

A 5-step checklist for using the golden window well

If you’re in (or approaching) the golden window, here’s a simple annual process:

1. Measure your window: how many years until RMDs start?

   
   

2. Add up other income: Social Security, pension, dividends, capital gains – everything that affects your bracket.

   
   

3. Choose your strategy: bracket-filling or another multi-year plan with your advisors.

   
   

4. Plan the tax payment: ideally from outside the IRA.

   
   

5. Revisit the strategy every year: repeat annually if it makes sense until RMDs begin.

   
   

Roth conversions can be done anytime – even after RMDs start but the years between retirement and RMDs often offer the biggest planning advantage. The golden window is a real opportunity – but like any opportunity, you don’t want to waste it.

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This material is being provided for informational purposes only and is not a complete description, nor is it a recommendation. Any opinions are those of the author and not necessarily those of Raymond James. All opinions are as of this date and are subject to change without notice. There is no guarantee that these statements, opinions or forecasts provided herein will prove to be correct. Investing involves risk and you may incur a profit or a loss regardless of strategy selected. Prior to making an investment decision, please consult with your financial advisor about your individual situation.

While we are familiar with the tax provisions of the issues presented herein, as Financial Advisors of RJFS, we are not qualified to render advice on tax or legal matters. You should discuss tax or legal matters with the appropriate professional.

Unless certain criteria are met, Roth IRA owners must be 59½ or older and have held the IRA for five years before tax-free withdrawals are permitted. Additionally, each converted amount may be subject to its own five-year holding period. Converting a traditional IRA into a Roth IRA has tax implications. Investors should consult a tax advisor before deciding to do a conversion.