Roth Conversion Tax Impact

How Roth conversions add to taxable income and fill lower tax brackets

How it works

Roth conversions move money from tax-deferred accounts (Traditional IRA) to tax-free accounts (Roth IRA). The conversion amount is added to ordinary income for the year and taxed at marginal rates. Strategic conversions in low-income years can lock in lower tax rates.

  1. 1. Conversion Adds to Ordinary Income

    Full conversion amount is added to AGI as ordinary income

    New AGI = Base AGI + Conversion Amount
    Example: Base AGI $80k + $30k conversion = $110k AGI for the year

  2. 2. Calculate Tax on Conversion

    Conversion is taxed at marginal tax rates

    Tax on Conversion = Marginal Tax Rate(s) × Conversion Amount
(May span multiple brackets)
    Example: In 22% bracket: $30k conversion → ~$6,600 tax In 12% bracket: $30k conversion → ~$3,600 tax

  3. 3. Determine Bracket Headroom

    Calculate available space to top of target bracket

    Headroom = Top of Target Bracket - Current Taxable Income
(Accounts for standard/itemized deductions)
    Example: Target 22% bracket, current taxable income $70k, bracket top $100k → $30k headroom

  4. 4. Optimal Conversion Amount

    Fill headroom to top of target bracket

    Optimal Conversion = MIN(Available IRA Balance, Bracket Headroom)
    Example: $30k headroom in 22% bracket → convert up to $30k to stay in 22%

Real-world context

The Tax Bracket Arbitrage

Roth conversions work best when you can convert in low-tax years (early retirement, business loss year) and avoid higher taxes in high-income retirement years (large RMDs). Converting $100k at 12% now is better than forced RMDs taxed at 22% later.

Multi-Year Conversion Strategy

Instead of one large conversion, spreading conversions over multiple years allows the client to fill low brackets repeatedly. Convert just enough each year to stay in the 12% or 22% bracket, avoiding spikes into higher brackets.

Pay Tax From Outside Funds

Paying conversion taxes from taxable accounts (not the IRA itself) maximizes the benefit. This moves more money into the tax-free Roth account and avoids early withdrawal penalties if under age 59½.

IRS reference: Publication 590-A - Contributions to IRAs

What drives the result

Conversion Amount
Strategies → Roth Conversion

Larger conversions mean higher current taxes but more tax-free growth

$50k conversion in 22% bracket → $11k tax now, saves ~$45k tax in retirement

Maximum Tax Bracket
Strategies → Roth Conversion (Auto Mode)

Sets upper limit for conversions - won't convert into higher brackets

Max bracket 22% → converts up to $100k/year, avoiding 24% bracket conversions

Traditional IRA Balance
Assets tab → Tax-Deferred Assets

Larger IRA means more potential for conversions and tax savings

$500k IRA can support 10 years of $50k conversions

Assumptions

  • Traditional IRA has no basis (all contributions were pre-tax)
  • Tax brackets indexed for inflation in future years
  • Conversion amount is paid from outside funds (not from IRA)
  • No state income tax impact modeled (federal only)
  • All Roth distributions are treated as tax-free — the account-level 5-year rule (earnings taxable if account < 5 years old) and the conversion-level 5-year rule (10% penalty on converted principal if withdrawn within 5 years of conversion while under age 59½) are both assumed to be satisfied; neither clock is tracked in the projection

Limitations

  • Does not optimize across multiple years simultaneously
  • State tax impact not calculated
  • Does not account for potential increases in Medicare premiums (IRMAA)
  • Pro-rata rule for IRAs with basis simplified

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.