What is a Roth Conversion?
A Roth Conversion refers to the process of transferring money from a tax-deferred account to a Roth IRA, where the growth will not be taxed. The Planner is designed to help you project your future income and income tax liabilities. Once you’ve got an accurate plan, your plan may indicate a period with a low income tax rate relative to subsequent years. If you have excess income to pay more in income tax, you can perform a Roth Conversion or two. This means you transfer the tax deferred money to the Roth and pay the taxes in the year of the conversion. You’re waging a bet that paying taxes early is going to equalize your tax rate across your lifetime and reduce your total lifetime income tax.
See this video to learn how to use the Roth Conversion Explorer.
What are the assumptions underlying the Roth Conversion Explorer?
The Explorer will solve for one of three strategies
Annual conversions will not exceed your plan’s average effective tax rate when choosing the highest estate value strategy and the lowest lifetime tax strategy. This means that you may be able to achieve a higher estate value strategy or the lower lifetime tax rate manually.
If your after-tax accounts have a higher growth rate than your tax-deferred accounts, the Explorer may not suggest an optimized plan because allowing the after tax money to grow will result in a higher net worth.
The charts illustrating the current plan compared to the optimized plan include any Roth Conversions you have entered in your plan.
The Explorer assumes that the converted funds will grow at the same rate as the current tax deferred account.
If you have entered a future rate change in your accounts, you may be unable to reproduce the Optimized Plan suggested by the Roth Conversion Explorer.
The Explorer assumes that assets in your current 401k are not eligible for conversions until you are 59 ½. If you want your current plan to be included in the Explorer Plan, change your account type to "Former 401k."
Traditional IRAs and "Former 401ks" will be included. If you want an account excluded and you are under 59.5, change your account type to "Current 401k."
If you do not have enough funds in after-tax accounts to cover the tax liability prior to age 59 ½, conversions will not be suggested.
After age 59 ½ the optimized plan will utilize converted assets to pay the taxes on the conversion after after-tax assets have been depleted.
In the optimized plan, accounts are converted in order of optimistic growth from high to low.
Tax rates are based on the assumption you select in My Plan > Assumptions > Taxes
529 and HSA accounts are excluded.
The Explorer makes an assumption that all Traditional IRA accounts and all Other Pre-Tax accounts are eligible for conversion. This may be an issue if you have an inherited IRA or other non-eligible tax-advantaged accounts modeled in your plan.
The Explorer does not include the current year in the optimized plan. If you would like a detailed plan for current year conversions, you may want to utilize our 2023 Roth Conversion Calculator.
Can I apply the suggested Roth Conversions to my plan?
We don’t currently support a “click and apply” method for the Roth Conversion Explorer. Overall the Explorer is a great place for insights. From there you can consider performing conversions on a year by year basis as your plan dynamics change and you choose to pay taxes ahead of time.
What are the assumptions underlying Roth Conversions in Money Flows?
Prior to age 59 ½ the planner will drain 100% of your taxable assets to pay the taxes. This may not be what you want/intend to do.
If you are converting prior to age 59 ½, you may be subject to a penalty for early withdrawal. This is not calculated in the Planner but you will get a coach alert.
When you create a Roth Conversion in Money Flows, the Planner creates a new account entitled Roth Conversions. You have the ability to modify the growth rates for this account. We suggest you use the same growth rates as any current Roth IRA. However, if you do this and model the conversions suggested in the Roth Explorer, you will see different results.
Roth Conversions do not satisfy RMD requirements.
See this video to learn how to Model Roth Conversions in My Plan > Money Flows
How are the taxes on Roth Conversions paid?
When you perform a Roth Conversion the assumption is that you are paying taxes from outside of the IRA first. The taxes are paid in accordance with our plan operations and withdrawal order. If additional funds are needed, the Planner will use funds from the source IRA being converted (conversion proceeds) if you make that selection.
It's essential to use your own discernment and consider your investing and planning temperament prior to executing any financial strategy. We also recommend that you validate your strategies with a tax professional or your tax software.
Please see our article on the Withdrawals for further information.