The value of converting pre-tax retirement assets into Roth accounts has been discussed quite often in financial planning publications, but the after-tax benefits of making those conversions can be significant. A person’s marginal tax brackets at the times of conversion and distribution must be considered. However, the long-term value of tax-free compounded earnings in a Roth account will often outweigh any reduction of an individual’s marginal tax rate at the time of distribution.
Roth conversions can trigger additional hidden taxes in the year of conversion by:
Increasing the amount of Social Security income that's taxed.
Pushing your capital gains tax rates into a higher bracket.
Subjecting investment income to an additional 3.8% tax. (Net Income Investment Tax)
Decreasing the amount of medical expenses you can deduct.
Increasing Medicare premiums.
Reducing tax credits that are phased out based on income, such as the Child Tax Credit, Dependent Care Credit, and certain education credits.
It may be psychologically painful to pay additional taxes at the time of conversion, but retirees should consider that if funds remain in a pre-tax retirement account, the Internal Revenue Service has a continuing claim on all earnings and principal in the account.
It is useful to think of Roth conversions as a form of longevity insurance. Although the nominal value of your retirement accounts may appear lower in the short term after conversion, in the long run, the after-tax value of these accounts could add hundreds of thousands of dollars to an individual’s retirement assets.
Fulcrum Wealth Advisors can provide clients with calculations showing the value of Roth conversions. We can also recommend amounts to convert to Roth accounts on an annual basis using tax projections based on a client's income and resources.
For more information and a discussion about Roth IRA conversions, see: