Roth conversions have been a hot topic for a while, thanks largely to the generationally low federal income tax rates we currently have under the Tax Cuts and Jobs Act. I know many advisors who advocate doing Roth conversions. Similarly, many clients have been asking whether they should do Roth conversions. However, trying to put a number on how beneficial conversions are (or aren’t) is close to impossible and should ideally be avoided, in my opinion.
Basics of Roth Conversion Analysis
At a high level, the decision of whether to do Roth conversions comes down to the effective tax rate the client falls under now, compared with the effective tax rate they’ll be subject to in the future. If they’re in a higher effective tax rate now, they shouldn’t convert. If they’re in a lower effective tax rate now, they should convert. Simple, right? Not exactly.
Figuring out a client’s current effective tax rate is quite easy to do. However, trying to figure out a client’s future effective tax rate is virtually impossible. Multiple very important variables go into that calculation. Furthermore, none of those variables can be predicted with certainty. Additionally, relatively small changes in the assumed values of those variables can significantly impact the outcome of the analysis.
The Factors that Influence the Value of Roth Conversions
To understand the futility of trying to quantify the value of Roth conversions, it’s important to know the main variables that will impact the analysis:
Tax Rates and Brackets
Although we know federal tax rates and brackets are due to increase in 2026 upon the sunsetting of the Tax Cuts and Jobs Act, we have no idea what changes may occur beyond that. Tax legislation is highly dependent on political party control, which is subject to change every two years. As such, trying to predict the future of tax legislation is nothing more than a random guess. Sure, given the country’s deficit and level of debt, I think it’s safe to assume taxes are more likely to go up than go down in the future. But when and by what extent is anybody’s guess.
It’s clear that tax rates and income brackets affect a client’s effective tax rate. But how about other direct or indirect taxes? For example, 10 years ago there was no such thing as the Net Investment Income Tax. This tax is an additional 3.8% flat tax that’s applied to the passive investment income of taxpayers whose gross incomes exceed certain thresholds. What’s to say there won’t be other new tax provisions like this in the future? And if there are, how are we supposed to attempt to quantify something that doesn’t even currently exist?
Also, don’t forget about things like the Medicare premium surcharge known as Income Related Monthly Adjustment Amount, or IRMAA. While IRMAA is not technically a tax, it functionally is. That’s because it’s an additional amount of money you need to pay (for Medicare) based on the amount of your income. Like all forms of legislation, who knows what the future of Medicare legislation will hold in terms of IRMAA or other similar potential provisions.
Financial Market Returns
We all know that trying to guess the future of the stock and bond markets is a fool’s game. However, you can’t attempt to quantify the value of Roth conversions without making such guesses. For example, most advisors rightfully advocate putting higher growth assets in Roth accounts so all the growth will eventually be tax-free. Furthermore, it generally makes sense to put lower growth assets in tax-deferred accounts, to try to minimize the amount of future taxable income the client will have from growth in those accounts. All else being equal, the higher the assumed growth of the Roth assets, the more valuable a conversion will be (because the more growth will be shifted from the tax-deferred account to the tax-free Roth account, which means less taxable income in the future).
What if future stock market returns end up being much lower than originally guessed? In that case, the value of conversions will end up being much smaller. Or, at one extreme, what if the stock market enters a prolonged period of drawdown, like Japan’s Nikkei 225, which is still not back to the peak it reached in the late-80s? In that case, it’s quite possible it will end up better to have not converted.
Required Minimum Distribution Rules
One of the main reasons for embracing Roth conversions is to help minimize the taxable required minimum distributions (“RMDs”) clients eventually have to take. When piled on top of Social Security, pensions, annuities, taxable account dividends, etc., RMDs can spike a client’s income and drive up their effective tax rates (and things like IRMAA). While we know the current RMD rules, they are always subject to change. For example, as of the writing of this article, legislation is working its way through Congress that would raise the RMD beginning age by three years, to 75. What if the RMD beginning age eventually increases even more? Or what if RMDs get completely eliminated at some point?
Client Longevity and Changes in Marital Status
The benefit a client will ultimately receive from Roth conversions is at least partially determined by how long he or she will live. For example, a client who is single must live long enough to recoup the loss of assets attributable to the taxes paid on the conversion. In other words, if a client converts $100,000 and must pay $15,000 of tax on that conversion, the client has $15,000 less of investable assets immediately after the conversion. Factor in some time value of money and it’s clear it’s going to take a while for that current $15,000 tax expense to pay off.
Changes in marital status will also impact the ultimate value of conversions. All else being equal, the benefit from conversions will be greater for a married couple if one of them passes prematurely than if both live a long time. This is because of the “widow(er) tax penalty”: Income-tax brackets compress and the standard deductions decrease for a surviving spouse whose tax-filing status changes to single from married filing jointly. On the other hand, if a single person does a Roth conversion and then gets married, a conversion will potentially be of less value because that person’s standard deduction would increase and their income tax bracket would, too.
To Run Projections or To Not Run Projections
Think about your financial planning software and how all the above variables play into the projections that software does. Try running a Roth conversion analysis with the software’s default assumptions for future tax rates, stock and bond market returns, RMD rules, client/spouse longevity, etc. Then rerun the analysis, but assume future tax rates move up or down by a few percentage points. Or assume the stock or bond market’s future returns are a few percentage points higher or lower. Or assume the RMD beginning age gets bumped up a few more years or potentially eliminated. Or assume a client passes a handful of years sooner or later than originally assumed.
You’ll notice these relatively small tweaks in assumptions will have fairly large impacts on the resultant “value” of doing Roth conversions, especially if you and the client were planning on doing sizable amounts of conversions. With that in mind, should you even do Roth conversion projections at all? That is the question …
What I Do (and Don’t Do)
The way I frame the value of Roth conversions to clients is less about a tangible dollar amount of savings they will experience and more about a hedge and peace of mind. It’s a hedge against some of the future unknowns and their tax impacts. Regardless what the future may be for tax legislation, market returns, RMDs, etc., having money in Roth accounts means the client won’t have to worry about that money getting taxed again. With that comes some peace of mind: They know they got taxes out of the way now and won’t have to worry as much about the tax impacts of all of those unknowns.
“The math nerd in me struggles to not wrap some kind of quantifiable number around the value of Roth conversions.”
The math nerd in me struggles to not wrap some kind of quantifiable number around the value of Roth conversions. But the realist in me knows there are way too many big and important variables that will fluctuate – potentially wildly – from whatever my original assumptions are. Therefore, I’m reluctant to try to get too numeric with my Roth conversion discussion with clients. Instead, I talk through the potential pros and cons and how lots of things will impact the value realized from Roth conversions. From there, clients and I kind of make a subjective decision of how much conversion, if any, feels “right” for them.
Admittedly, my approach toward Roth conversions is very unscientific. However, until my crystal ball starts working, I’m hesitant to try to predict the future.
Andy Panko, CFP, RICP, EA, is the owner of Tenon Financial, a fee-only firm in Metuchen, N.J., that provides tax-efficient retirement planning and investment management. He’s also the founder and moderator of the Facebook group Taxes in Retirement, creator of the YouTube channel Retirement Planning Demystified and host of the podcast Retirement Planning Education.