Roth IRA Conversion Strategy
Convert Traditional IRA to Roth IRA by paying tax now at current rates to create tax-free retirement income and eliminate future RMDs. Strategic timing can reduce lifetime tax liability.
How it works
Roth conversions involve transferring funds from Traditional IRA (pre-tax) to Roth IRA (after-tax). You pay ordinary income tax on the converted amount in the conversion year, but all future growth and withdrawals are tax-free. The strategy is most effective during low-income years (early retirement, business loss) when marginal tax rates are lower than expected future rates.
1. Calculate Current Tax Bracket and Headroom
Determine your current marginal tax bracket and how much income you can recognize before reaching the next bracket. This 'bracket headroom' is the optimal conversion amount.
Bracket Headroom = Top of Target Bracket - (Current AGI - Deductions)
Example: AGI $100k, deductions $30k, in 12% bracket (up to $94,300 taxable income). Headroom: $94,300 - $70,000 = $24,300 can convert at 12% rate.2. Identify Optimal Conversion Years
Best years: (1) Early retirement before Social Security/pensions start, (2) Business loss or sabbatical years, (3) Years before RMDs begin at age 73 or 75 (depending on birth year per SECURE 2.0). Avoid high-income years.
Example: Retire at 62, delay Social Security until 67. Years 62–66 are optimal for conversions before Social Security benefits begin and increase AGI.3. Calculate Conversion Tax Cost
Tax paid equals converted amount times marginal tax rate. Consider state taxes too. This is a 'prepayment' of future taxes at today's rates.
Conversion Tax = Conversion Amount × (Federal Marginal Rate + State Rate)
Example: $50k conversion at 22% federal + 5% state = $13,500 tax cost4. Project Future Tax Savings
Future Roth distributions are tax-free vs. Traditional IRA distributions taxed as ordinary income. Savings = avoided future taxes minus conversion tax paid.
Lifetime Savings = Future Tax Avoided - Conversion Tax Paid (discounted to present value)
Example: Convert $50k at 22%, avoid $80k future distributions taxed at 24% = $19,200 - $11,000 = $8,200 net savings (NPV)5. Consider RMD Elimination Benefit
Roth IRAs have no RMDs during owner's lifetime. Converting reduces future RMD amounts, preventing forced income that can trigger higher tax brackets, Medicare surcharges, and Social Security taxation.
Real-world context
Tax Rate Arbitrage
The core benefit of Roth conversions is paying tax at today's known rate vs. uncertain future rates. If you convert at 12% and avoid future distributions at 22%, you save 10 percentage points. Even if rates stay the same, you benefit from tax-free growth and RMD elimination.
IRS reference: Publication 590-A - Roth IRA Conversions
Roth 5-Year Rule
There are two distinct Roth 5-year rules — they operate independently and serve different purposes. Rule 1 — Account-level (IRC §408A(d)(2)(B)): Roth IRA earnings are only tax-free if the account has been open for at least 5 years (measured from January 1 of the tax year of the first contribution or conversion to any Roth IRA — it is a per-person clock, not per-account). If this rule is not met, earnings are subject to income tax when distributed. Age 59½ eliminates the 10% penalty but does not waive the income tax on earnings if the 5-year rule is unsatisfied. Rule 2 — Conversion-level (IRC §408A(d)(3)): Each Roth conversion has its own 5-year clock. If converted principal is withdrawn within 5 years of the conversion AND the owner is under age 59½, the 10% early withdrawal penalty applies to the withdrawn converted amount (income tax does not apply again — it was paid at conversion). Once the owner reaches age 59½, the conversion 5-year clock becomes irrelevant — no penalty applies regardless of when the conversion occurred. Projection assumption: Stratum treats all Roth distributions as tax-free and penalty-free. For clients who are age 59½ or older, or whose Roth account has been open more than 5 years, this assumption is correct for nearly all cases. For younger clients with recent conversions, advisors should verify that the applicable 5-year clock is satisfied before projecting tax-free treatment.
IRS reference: IRC §408A(d)(2)(B) (account rule); IRC §408A(d)(3) (conversion rule); IRS Publication 590-B
RMD Elimination Strategy
RMDs begin at age 73-75 and force taxable distributions whether you need the money or not. Large Traditional IRA balances can push retirees into higher brackets. Converting during the 'gap years' (retirement to RMD age) reduces future RMD amounts and associated tax problems.
Medicare IRMAA Considerations
Large conversions can trigger Medicare Income-Related Monthly Adjustment Amount (IRMAA) surcharges on Part B and Part D premiums. IRMAA based on MAGI from 2 years prior. Plan conversions to avoid IRMAA cliffs or spread over multiple years.
How Auto-Mode Sizes the Conversion Amount
When Roth Conversion is set to auto-mode (fill bracket / IRMAA tier), the engine always runs the conversion last in the strategy pipeline so it can size against the full year's tax picture. This applies regardless of where Roth sits in the strategy list — even if the advisor places Roth first, auto-mode is deferred to the tail of the pipeline. The Strategy Panel shows an 'Auto — runs last' badge on the card to signal this. Why this matters: if auto-mode sized the conversion before other strategies (Structured Withdrawals draws, Social Security, Strategic Contributions, Charitable Giving deductions, Tax Harvesting gains, etc.) had run, it would see an artificially low income, mistakenly believe more bracket room remained, and over-convert into a higher bracket. Even fixed-amount strategies like a QCD or harvest schedule have to be visible to the conversion probe — placing them after Roth in the list would otherwise hide them. Advisor implication: the Roth conversion amount in auto-mode is driven by the year's income picture, not by where Roth sits in the strategy list. To change the conversion amount, change the inputs to the year's income (withdrawals, contributions, SS claim age, charitable deductions, harvest gains) or change the target bracket / IRMAA tier — not the strategy order. Card position is purely visual when auto mode is on. Auto-mode Structured Withdrawals also runs last (just before auto-mode Roth) for the same reason. Manual-mode Roth conversions (fixed dollar amount per year) follow advisor-set order normally — they apply exactly the amount the advisor specifies, in whatever sequence the advisor sets.
What drives the result
Larger conversions increase current-year tax but create more tax-free future income. Optimal amount fills lower brackets without spilling into higher brackets.
Converting $50k at 22% saves more than converting $100k with $50k at 22% and $50k at 24%
Larger balances have more tax liability to address. More conversions needed to reduce future RMDs. Larger balances also mean more tax-free growth potential after conversion.
$500k Traditional IRA → $20k annual RMDs at age 75. Converting $100k over 5 years reduces RMDs by ~$4k/year.
Lower current brackets make conversions more attractive. Moving from 12% to 22% bracket is key inflection point for most retirees.
Convert $30k/year during 12% bracket years vs. facing 22% on all Traditional IRA distributions later
Earlier retirement creates more gap years for low-bracket conversions. Each year of gap between retirement and Social Security/RMDs is conversion opportunity.
Retire at 60, Social Security at 67 = 7 years of conversion opportunities
Assumptions
- Future tax rates equal or exceed current rates (conservative assumption)
- All Roth IRA distributions are treated as tax-free in the projection — this implies: (1) the account-level 5-year rule is satisfied (Roth account has been open at least 5 years), and (2) either the conversion-level 5-year rule is satisfied for each converted tranche, or the owner is age 59½ or older (making the conversion penalty irrelevant); see 5-Year Rule in Important Considerations for details
- Conversion tax paid from non-retirement funds (paying from IRA reduces benefit)
- Traditional IRA has no after-tax basis (basis requires pro-rata calculation)
- Investment returns equal in Traditional and Roth accounts
- No state income tax on Roth distributions (most states)
Limitations
- Does not model Roth conversion recharacterization (eliminated after 2017)
- Does not account for impact on ACA subsidies or other income-based benefits
- Simplified tax bracket projection (actual brackets indexed for inflation)
- The conversion-level 5-year clock is not tracked per conversion — for clients under age 59½ who convert and withdraw within 5 years, the 10% early withdrawal penalty on converted principal is not modeled; the account-level 5-year rule (for earnings) is also assumed to be met
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Related
This page explains how Stratum models this calculation. It is educational material for financial professionals, not tax or legal advice, and tax law changes. Verify current figures against primary IRS sources before relying on them with a client.