IRA Rescue: Could a Roth Conversion Improve Your Retirement Income and Legacy?
For many successful professionals, business owners, and families approaching retirement, a substantial portion of their wealth may be accumulated in traditional IRAs, 401(k)s, and other tax-deferred retirement accounts.
A retirement account statement might show $1 million, $2 million, or more. But the account balance alone doesn't answer an important question:
How much of that money may ultimately be available for you to spend after taxes—and how much may eventually pass to your family?
Traditional retirement accounts can provide valuable tax deferral during your working years. However, tax deferral is generally not tax elimination. Distributions of previously untaxed amounts from traditional IRAs and retirement plans are generally subject to ordinary income tax, and required minimum distributions (RMDs) may eventually require distributions whether or not you need the income.
For individuals with substantial qualified retirement assets, this creates an important planning question:
Should you continue with your existing IRA strategy, or could a partial Roth conversion or other tax-diversification strategy warrant consideration?
That is one of the questions our IRA Rescue analysis is designed to help evaluate.
What is an IRA Rescue Analysis?
“IRA Rescue” is a marketing name used by Quality Financial Planning to describe a financial planning analysis. It is not an IRS program, retirement account type, or guarantee of improved financial results.
The analysis is designed to help evaluate whether repositioning a portion of substantial pre-tax retirement assets may be appropriate as part of a client's broader retirement income, tax diversification, accumulation, and legacy strategy.
A Roth conversion is not appropriate for everyone.
Our objective is not to begin with the assumption that you should convert your IRA.
Instead, we start with an important baseline:
What could happen if you maintain your current strategy?
We can then compare that baseline with alternative planning scenarios based on your financial circumstances, objectives, and stated assumptions.
What is a Roth Conversion?
A Roth conversion generally involves moving eligible assets from a traditional IRA or other eligible pre-tax retirement account into a Roth IRA.
The previously untaxed portion of the amount converted generally becomes taxable income in the year of conversion.
Therefore, a Roth conversion isn't simply a way to “avoid taxes.” In many cases, it represents a decision to pay income taxes sooner in exchange for the potential benefits associated with Roth assets later.
If applicable requirements are satisfied, qualified Roth IRA distributions can generally be received free of federal income tax. Roth IRA owners also generally aren't required to take minimum distributions during their lifetimes.
This changes the planning question from simply:
“How much tax will I pay if I convert?”
to:
“How could paying taxes today compare with continuing to defer taxes under different future scenarios?”
Who May Benefit From a Roth Coversion Analysis?
An IRA Rescue analysis may be particularly relevant for individuals or married couples who have accumulated substantial assets in traditional IRAs, 401(k)s, 403(b)s, or other qualified retirement accounts.
For example, an analysis may warrant consideration when someone:
- Has significant pre-tax retirement assets.
- Has other investments, savings, pensions, Social Security, business assets, or income sources.
- Doesn't expect to need all qualified assets for immediate retirement expenses.
- Is concerned about future required minimum distributions.
- Wants greater tax diversification during retirement.
- Has non-retirement assets that could potentially be used to pay conversion taxes.
- Wants to evaluate future retirement income needs.
- Has legacy or estate-planning objectives.
- Wants to compare the existing strategy with alternatives rather than make a decision based solely on today's tax consequences.
Having a large IRA, however, does not mean a Roth conversion is automatically appropriate.
The decision should be evaluated within the client's complete financial and tax situation.
Your IRA Balance Doesn't Tell the Whole Story
Suppose your retirement statement shows $1.5 million in a traditional IRA.
It is easy to think:
“I have $1.5 million available for retirement.”
But the account balance doesn't tell you how much may ultimately be available after taxes.
The outcome can depend on factors including future withdrawals, investment performance, tax rates, required minimum distributions, Social Security and pension income, other investments, healthcare expenses, longevity, and what eventually happens to the account at death.
That is why retirement planning should generally consider more than the account balance.
The objective is to understand how your assets may potentially support your retirement income, financial flexibility, and legacy objectives over time.
Roth Conversions and Required Minimum Distributions
Required minimum distributions can become an important consideration for retirees with substantial tax-deferred retirement accounts.
Traditional IRAs are generally subject to RMD requirements beginning at the applicable age under federal law. Distributions generally create taxable income to the extent they represent previously untaxed amounts.
Roth IRA owners, by contrast, generally aren't required to take RMDs during their lifetimes.
Converting a portion of traditional IRA assets to Roth assets may therefore reduce the amount remaining in accounts potentially subject to future RMDs.
However, reducing future RMDs doesn't by itself establish that a Roth conversion is beneficial.
The current tax cost, future tax assumptions, investment horizon, liquidity needs, and other financial consequences should also be evaluated.
Look Beyond the Immediate Conversion Tax
The immediate tax cost of a Roth conversion is understandably one of the first concerns for many investors.
It is important—but it isn't the only consideration.
A more comprehensive analysis may examine:
- Taxes associated with a proposed conversion.
- Potential future retirement distributions.
- Projected account values.
- Tax characteristics of future distributions.
- Required minimum distributions.
- Potential legacy values.
- Longevity assumptions.
- Sources used to pay conversion taxes.
- Other assets and income available to the client.
- Potential effects on other income-related planning considerations.
The objective is to evaluate the overall strategy, rather than looking at one tax transaction in isolation.
Four Planning Approaches We Can Evaluate
Different retirees have different financial objectives.
Someone focused primarily on retirement income may require a different analysis from someone primarily interested in long-term accumulation or leaving assets to beneficiaries.
Our analysis can evaluate several planning approaches.
1. Income-Focused With a Legacy Objective
This approach places greater emphasis on potential lifetime retirement income while also considering the client's legacy objectives.
Depending on the client's circumstances, the broader financial plan may separately evaluate life insurance as one potential method of addressing legacy objectives.
Life insurance is not held within an IRA, and a Roth conversion and the purchase of an insurance product are separate transactions.
2. Income With Greater Emphasis on Account Value
This approach evaluates a balance between potential retirement distributions and maintaining assets for future financial needs or beneficiaries.
3. Balanced Toward Long-Term Growth
This approach places greater emphasis on potential long-term accumulation while still considering retirement income, tax diversification, liquidity, and legacy objectives.
It may be relevant for individuals who have other income sources and don't expect to rely heavily on these assets for current retirement spending.
4. Accumulation-Focused With No Planned Current Income
This approach focuses primarily on long-term accumulation and legacy objectives rather than current retirement distributions.
It may warrant consideration for individuals who expect other resources—such as Social Security, pensions, taxable investments, business income, or real estate—to meet a substantial portion of their retirement income needs.
These planning approaches are illustrations for analysis and are not recommendations or guarantees of results. The appropriate strategy, if any, depends upon each client's individual circumstances.
Compare Potential Outcomes Under Different Planning Scenarios
Retirement and tax decisions involve numerous assumptions.
Rather than focusing on a single account balance or tax calculation, our analysis can compare different planning scenarios using a client's financial information and stated assumptions.
Depending on the strategy being evaluated, the analysis may consider:
Potential after-tax retirement income, projected account values, amounts contributed or committed to a strategy, and potential legacy values.
These comparisons can be evaluated through different planning ages to help illustrate how longevity may affect potential outcomes.
Any such analysis is hypothetical and depends on assumptions that may change. It does not represent actual investment results and cannot predict or guarantee future outcomes.
What Happens If You Live Longer--or Die Earlier--Than Expected?
No one knows exactly how long he or she will live.
For that reason, relying on a single life-expectancy assumption can provide an incomplete picture.
An analysis can evaluate different longevity scenarios to illustrate how potential outcomes might change.
For example:
What happens if I live substantially longer than anticipated?
How might the strategy affect my spouse if I die first?
What could happen to remaining assets if I die earlier?
How might potential legacy values change at different ages?
Examining multiple scenarios can provide additional context when evaluating a long-term retirement strategy.
A Roth Conversion Can Affect More Than Your Income-Tax Bill
Roth conversion planning should consider more than federal income-tax brackets.
Because a Roth conversion can increase taxable income in the conversion year, it may affect other income-sensitive areas of a financial plan.
Depending on individual circumstances, these may include Medicare income-related premium adjustments, taxation of Social Security benefits, deductions, credits, capital-gain taxation, and other tax considerations.
For people approaching or enrolled in Medicare, this can be particularly important because higher income can potentially result in income-related adjustments to Medicare Part B and Part D premiums.
This is one reason why the question of how much to convert and when can be just as important as whether to convert.
For some individuals, a series of partial conversions over multiple tax years may warrant evaluation rather than a single large conversion.
How Will You Pay the Roth Conversion Tax?
Another important planning consideration is the source of funds used to pay taxes resulting from a Roth conversion.
For some individuals, paying the tax from cash or other non-retirement assets may allow more converted assets to remain in the Roth IRA.
However, using outside assets also has consequences. Those assets may have other investment opportunities, liquidity needs, or financial purposes.
Using IRA assets to pay taxes can also affect the amount ultimately converted and may have additional consequences depending on the individual's age and circumstances.
There is no universal answer.
The source of funds used to pay conversion taxes should therefore be incorporated into the overall analysis.
Roth Conversion and Legacy Planning
Legacy planning can be particularly important for individuals who expect to leave substantial retirement assets to children or other beneficiaries.
Inherited traditional IRA distributions are generally taxable to beneficiaries to the extent the distributions consist of previously untaxed amounts.
Inherited Roth IRAs are also subject to beneficiary distribution rules, but qualifying Roth distributions can have different income-tax characteristics.
The applicable rules depend on factors including the beneficiary's relationship to the account owner and other circumstances.
Therefore, instead of focusing exclusively on the account balance left at death, another useful planning question may be:
What potential after-tax value could ultimately be available to your beneficiaries?
Tax and estate-planning professionals should be consulted regarding individual inheritance and estate-planning circumstances.
When Might A Roth Conversion Not Make Sense?
A balanced analysis should also consider circumstances in which a Roth conversion may be less attractive.
Examples may include situations where:
- Future taxable income is expected to be substantially lower.
- A conversion would create an undesirable current tax consequence.
- Additional income could significantly affect Medicare or other income-related costs.
- Adequate liquidity isn't available to comfortably pay conversion taxes.
- The retirement assets may be needed in the near term.
- Other tax or financial-planning strategies may be more appropriate.
- The potential projected benefits aren't sufficient to justify the immediate tax cost and associated risks.
This is why analysis should come before implementation.
The purpose should not be to justify a Roth conversion. It should be to determine whether one warrants consideration based on the client's circumstances.
Roth Conversions Are Generally Irreversible
Roth conversion decisions deserve careful consideration for another reason.
Under current federal tax law, a completed Roth conversion generally cannot be recharacterized back into a traditional IRA.
That makes it particularly important to evaluate the tax consequences before proceeding.
A decision should not be based solely on predictions about future tax rates or generalized statements that everyone should convert before taxes increase.
Individual circumstances matter.
The Question Isn't Simply "Roth or Traditional?"
For someone approaching retirement with substantial qualified assets, the analysis may involve several questions:
How much should I consider converting?
Over how many years?
When should conversions begin?
How might different conversion amounts affect my tax situation?
Should conversions be evaluated before required minimum distributions begin?
Could additional income affect Medicare premiums?
How much income will I actually need from these assets?
What resources will be available to my spouse?
How important is leaving assets to beneficiaries?
How do the results change under different longevity assumptions?
These are comprehensive financial-planning questions, not simply investment questions.
A Personalized IRA Rescue Analysis
At Quality Financial Planning, our IRA Rescue analysis is designed to help individuals and couples with substantial qualified retirement assets evaluate these questions using their own financial information and objectives.
Rather than relying solely on a generic illustration or rule of thumb, we can prepare a personalized analysis comparing the client's existing strategy with alternative planning scenarios.
Depending on the client's circumstances, the analysis may evaluate areas including retirement income, Roth conversions, tax diversification, projected accumulation, and legacy planning.
The purpose is not to convince someone to complete a Roth conversion or purchase a particular financial product.
The purpose is to provide information that can help the client, together with their financial and tax professionals, determine whether a change to the existing strategy warrants consideration.
Sometimes the analysis may identify an alternative worth considering.
In other situations, maintaining the existing strategy may be appropriate.
Either conclusion can provide useful information.
Is Your IRA Working the Way You Want It To?
If you have accumulated substantial assets in an IRA, 401(k), or another qualified retirement account, your current balance tells only part of the story.
It may also be helpful to understand how those assets could potentially support your retirement income, tax-diversification, liquidity, and legacy objectives under different planning scenarios.
A personalized IRA Rescue analysis can help you compare your existing approach with alternative Roth conversion and retirement-planning scenarios based on your financial circumstances and objectives.
Request a Personalized IRA Rescue Analysis →
Important Disclosure
This material is provided for educational and informational purposes only and should not be construed as individualized investment, tax, legal, or insurance advice or as a recommendation to implement a Roth conversion, engage in any particular investment strategy, or purchase any investment or insurance product.
“IRA Rescue” is a marketing name used by Quality Financial Planning to describe a financial planning analysis. It is not an IRS program, retirement account type, tax strategy approved or endorsed by the IRS, or guarantee of improved financial results.
Roth conversions can create significant current income-tax liabilities and may affect Medicare premiums and other tax- and income-related items. The appropriateness of a Roth conversion depends upon individual circumstances. Clients should consult with their tax professional regarding their individual tax situation before implementing a Roth conversion.
Any financial illustrations, projections, comparisons, or scenario analyses are hypothetical, are dependent upon assumptions that may change, do not reflect actual investment results unless specifically identified as such, and are not guarantees of future results. Actual results may differ materially from illustrated or projected results.
When insurance is evaluated as part of a financial planning strategy, insurance and Roth conversion transactions are separate. Life insurance cannot be held within an IRA. Insurance products are subject to policy terms, costs, limitations, underwriting requirements, surrender charges where applicable, and the claims-paying ability of the issuing insurance company.
Insurance products and services are offered through Reyes Benefits, Inc., a separate affiliated insurance agency owned by Mauricio Reyes, who is a licensed insurance agent.