A client recently told me that her sister-in-law was doing Roth conversions.
“Does it make sense for me?” she asked.
I love that question.
Most people skip it.
They hear about an idea, watch someone they trust pursue it, and start wondering what they’re missing out on.
Here’s what I’ve learned after 30+ years: whether a Roth conversion makes sense for you depends almost entirely on which buckets your money is currently spread across.
My client was already in good shape.
Three buckets of money
Most people think of their savings or their portfolio as a single dollar figure.
For tax planning in retirement, I find it far more useful to think about three buckets. Each one is taxed differently.
Your regular brokerage account. You pay tax each year on the dividends and interest, plus capital gains tax when you sell something that’s gone up. This is your most flexible tax bucket.
Your traditional IRA or 401(k). Money goes in before tax and grows tax-deferred. But every dollar that comes out is taxed as regular income. And starting in your 70s, the government makes you take money out whether you need it or not.
Your Roth IRA. You’ve already paid tax on the money going in. After that, it generally grows and comes out tax-free, no matter how big it gets.
A Roth conversion deliberately moves money from bucket 2 to bucket 3. You pay the income taxes now, ideally with cash from bucket 1, so more of your money is never taxed again.
Simple idea.
Whether it’s worth doing is much more involved.
A look at the numbers
I ran my client’s numbers through a tool that models decades of taxes. It compared her current plan against moving a large chunk of her traditional IRA (bucket 2) into her Roth (bucket 3) over the next few years.
The result: approximately $60,000 in taxes saved over her thirty-plus year life expectancy.
That’s real money.
But spread over three decades, it’s about $2,000 a year.
To get it, she’d have to write some big checks to the IRS over the next few years, keep a close eye on her income each year, and assume that tax laws and her own life play out the way the software assumed.
We talked it through. She decided the savings weren’t worth the added complexity, and she kept her plan as is. For now, at least.
I believe she made the right call for her situation.
Her answer came down to her buckets. She has a healthy brokerage account, a solid IRA, and some money already in a Roth. Because she has all three, we can better manage her tax planning going forward.
She already has a lot of the flexibility a Roth conversion is meant to achieve.
Who it can help
I’ve run the same analysis for clients with almost everything in a traditional IRA (bucket 2).
For some of them, Roth conversions can potentially save several hundred thousand dollars over their lifetime.
They have much less flexibility today.
Every dollar they spend gets taxed as income. And those required distributions in their 70s can push them into higher brackets for the rest of their lives.
Timing matters too. For many women I work with, the years between retirement and those required withdrawals are the lowest income tax years they’ll ever have. If you’re in that window, I think it’s worth at least looking at your own numbers.
Same analysis. Same math.
But completely different answer, because the starting mix across buckets was different.
I suspect that’s true for her sister-in-law, too. More in bucket two and less in the other two usually means more benefit from converting.
This is another great example of the “personal” aspect of personal financial planning.
The tradeoffs
Conversions can result in real benefits.
Money in a Roth grows tax-free and shrinks your required minimum distributions later. It’s also better than leaving a traditional IRA to your kids, since they can inherit it without an income tax bill attached.
They have real costs, too.
You pay the taxes now, sometimes a lot of it. A big conversion and the resulting taxable income can raise your Medicare premiums two years later. And you’re betting that paying tax today beats paying it later, with rates and laws nobody can predict.
I don’t take sides on Roth conversions. I’ve walked through the pros and cons with a lot of clients over the years, and I’m always glad to do it again.
Sometimes the numbers make a compelling case. Other times, like with this client, not so much. And sometimes the answer changes a few years later, after a market drop, an inheritance, or another change in circumstances.
That’s why I’d rather revisit this question as life unfolds than decide it once and forget about it.
What does concern me is anyone, advisor or relative, who tells you Roth conversions are always smart or always dumb without ever looking at your personal situation in detail.
What this means for you
Someone else’s mix, even a close relative’s, tells you very little about your own.
Before you follow a strategy you heard about from a friend or family member, ask yourself:
Do you know roughly how your savings are split across the three buckets?
Is the person you’re comparing yourself to actually in a similar position?
Has anyone run the actual numbers for you, or are you working off a feeling that you should be doing more?
If a conversion did save you money, would it change how you live, or just how a spreadsheet looks in 20 or 30 years?
That last question is the one I’d really focus on.
If the honest answer is “just the spreadsheet,” give yourself permission to let it go.
Bottom line: The strategy saving your sister-in-law real money might do very little for you. If so, that usually means you’ve done something right. Your buckets are already in good balance.
I’d love to hear: roughly how is your money split across the three buckets? Mostly in one, or spread out? Hit reply and let me know.
Until next Wednesday,
Russ
P.S. This idea goes well beyond Roth conversions. Delaying Social Security, buying an annuity, paying off the mortgage early, gifting to the kids. Whatever the strategy, and whoever's talking about it, the first question you should always ask: Does it work for me?
This piece is educational and informational only. It’s not tax, legal, or investment advice.