The Hidden Roth Conversion Window: Why the Opportunity May Be Shrinking

For many retirees, the traditional tax strategy sounds perfectly reasonable:

Retire. Keep your taxable income low. Leave the IRA alone. Pay as little tax as possible.

And for the first several years of retirement, that strategy can feel great.

The problem is what may happen later.

Your IRA or 401(k) continues to grow. Eventually, Required Minimum Distributions begin. Social Security may become taxable. One spouse may pass away, leaving the survivor filing as a single taxpayer. And if tax rates eventually move higher, some retirees could find themselves paying significantly more tax in their 70s and 80s than they did when they first retired.

That is why we believe there may be a unique planning opportunity for certain retirees right now.

We call it the Hidden Roth Conversion Window.

The Traditional Retirement Tax Strategy May Be Backwards

One of the most common things we see is a retiree entering retirement in their early 60s with a significant amount of money accumulated inside an IRA or 401(k).

Then something interesting happens.

Their CPA prepares their tax return and says, essentially, “You don’t need the money from your IRA, so let’s leave it alone.”

Their financial advisor is often comfortable with that too.

The retiree pays relatively little tax.

Everyone is happy.

But the tax bill may not have disappeared.

It may have simply been postponed.

If a $1 million, $2 million or $3 million IRA continues growing throughout retirement, eventually the IRS requires distributions from that account.

At that point, you may no longer be deciding if you want taxable income.

The government may be deciding for you.

That is one reason the first several years of retirement can be so valuable from a tax-planning standpoint.

Instead of asking:

“How little tax can I pay this year?”

We believe retirees should also be asking:

“How much tax will I pay over my entire retirement?”

Those are very different questions.

Are Taxes Really Low Today?

One of the biggest objections to accelerating taxes through Roth conversions is simple:

Why voluntarily pay tax today?

That is a fair question.

But it becomes more interesting when we look at tax history.

For our recent analysis, we went back to 1995 and created a hypothetical 75-year-old married couple.

We then compared what that couple would have paid under 1995 tax law with what a comparable retiree would pay under current tax law after adjusting the numbers for inflation.

The differences were significant.

Among them:

• Required Minimum Distribution rules forced retirees to withdraw a larger percentage of their retirement accounts.
• Standard deductions and other tax benefits were different.
• Most importantly, ordinary income tax brackets were considerably higher.

Under the assumptions we analyzed, the hypothetical retiree’s tax bill under the 1995 rules was dramatically higher than under today’s rules.

The point is not that tax law will return to 1995.

Nobody knows what Congress will do.

The point is that the tax rates retirees are paying today are not historically guaranteed.

Taxes have been much higher before.

They could be higher again.

The Federal Debt Changes the Conversation

There is another reason we believe retirees should at least consider the possibility of higher future taxes: the federal debt.

For years, researchers, think tanks and government agencies have warned about the long-term imbalance between federal spending and federal revenue.

There are only so many ways that imbalance can ultimately be addressed.

The government can reduce spending.

The economy can grow faster.

Inflation can reduce the real value of the debt.

Or the government can collect more revenue.

We do not know exactly which combination policymakers will choose.

But for retirement planning, we do not believe the correct approach is to simply assume today’s tax rates will remain unchanged for the next 20 or 30 years.

That may happen.

But it is only one possible future.

And a good retirement tax plan should consider more than one future.

Why the Roth Conversion Window May Be Shrinking

For many retirees, there is a period between retirement and the point when Required Minimum Distributions become significant.

During those years, taxable income may temporarily decline.

We sometimes refer to this period as the Golden Tax Planning Decade.

For certain retirees, this may be the best opportunity they will ever have to intentionally recognize income at today’s tax rates.

That could mean converting a portion of an IRA to a Roth IRA.

A Roth conversion means voluntarily moving money from a tax-deferred retirement account into a Roth account and paying the income tax today.

Why would anyone voluntarily do that?

Because once those dollars are inside the Roth IRA, future qualified withdrawals are generally tax-free, and Roth IRAs are not subject to lifetime Required Minimum Distributions for the original owner.

The potential benefit is not simply paying tax early.

The potential benefit is choosing when and potentially at what tax rate you pay that tax.

Roth Conversions Are Not for Everyone

This is important.

A Roth conversion is not automatically a good strategy.

And converting more is not automatically better.

Every retiree is different.

But there are certain characteristics that can make Roth planning particularly important.

For example, someone who:

• Is approaching or recently entered retirement
• Has seven figures accumulated in IRAs or 401(k)s
• Has strong retirement assets relative to their spending needs
• Is married
• Expects to leave retirement assets to children

may face a very different Roth conversion decision than someone who expects to spend most of their retirement assets during their lifetime.

For some families, Roth conversions could potentially create very large lifetime tax savings.

For others, aggressive conversions could actually reduce family wealth.

That is why we do not believe Roth conversions should be approached with a simple rule of thumb.

The Problem With the Roth Conversion “Easy Button”

Today, retirement-planning software can run Roth conversion calculations almost instantly.

Enter a few assumptions.

Click a button.

The software produces an “optimal” Roth conversion amount.

That can be helpful.

But we believe it can also create a false sense of precision.

What assumptions did the software make?

Did it assume tax rates stay exactly where they are today?

What happens if tax rates increase?

What happens if one spouse dies early?

What happens if both spouses live into their 90s?

What happens to the children who inherit the remaining retirement accounts?

Does the strategy minimize taxes?

Or does it maximize the amount of after-tax wealth ultimately available to the family?

Those are not always the same thing.

A Better Question: What Happens at the Family Finish Line?

This is why we developed what we call the Family Finish Line Framework.

Instead of looking only at the retiree’s next tax return, we want to look much further down the road.

We begin by asking:

What happens if tax rates remain relatively low?

Then we run the analysis again assuming future tax rates increase.

Next, we change longevity assumptions.

What if one spouse dies earlier than expected?

What if both spouses live well beyond average life expectancy?

Then we look beyond the retirees themselves.

If substantial assets are likely to remain, what happens when the children eventually inherit those assets?

At the end of each scenario, we ask a very simple question:

How much after-tax wealth is ultimately left for the family?

That is the finish line.

And sometimes the strategy that produces the lowest tax bill today is not the strategy that produces the best result at the finish line.

The Real Roth Conversion Question

Retirees often ask us:

“Should I do a Roth conversion?”

We think there is a better question.

“What Roth conversion strategy gives me and my family the best possible tax outcome across the different futures we may actually live through?”

That means evaluating multiple variables:

Future tax rates.

Longevity.

Required Minimum Distributions.

Social Security taxation.

Investment growth.

Retirement spending.

Estate planning.

And the taxes your children may eventually pay on inherited retirement accounts.

When all of those pieces are considered together, the Roth conversion decision becomes much more than a question about this year’s tax bracket.

It becomes a multi-generational retirement planning decision.

The Window Will Not Stay Open Forever

For retirees who are in their early or mid-60s, time matters.

Every year that passes is another year of potential IRA growth.

Every year that passes moves you closer to Required Minimum Distributions.

And every year that passes removes one more year in which you could have intentionally recognized income while you were still in a relatively low tax environment.

That does not mean every retiree should rush out and convert their IRA.

It means this is a decision that deserves serious analysis before the opportunity disappears.

Because the worst time to discover that you should have started planning five years earlier is five years from now.

Find Out Whether This Applies to You

If you are approaching retirement or already retired and have significant assets accumulated in IRAs or 401(k)s, this is exactly the type of planning question we help retirees evaluate.

Our goal is not simply to recommend a Roth conversion.

Our goal is to determine which strategy may give you and your family the strongest after-tax outcome across the different futures you may actually experience.

If you would like to see whether there may be retirement tax-planning opportunities in your situation, start with our complimentary AIM Assessment.

It takes less than one minute and helps us determine whether there may be areas of your retirement plan worth exploring.

Take the AIM Assessment:
https://cyrfinancial.net/aimassessment/

Cyr Financial Wealth Advisors is an SEC-registered investment adviser. This material is provided for educational purposes only and should not be considered individualized tax, legal or investment advice. Tax laws and individual circumstances vary. Consult your tax and financial professionals before implementing a Roth conversion or other tax-planning strategy.

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