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How to use the Roth Conversion Explorer
How to use the Roth Conversion Explorer

Some FAQs about Roth conversions and the Roth Conversion Explorer

Nancy Gates avatar
Written by Nancy Gates
Updated over a week ago

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.

What are the assumptions underlying the Roth Conversion Explorer?

The Explorer will solve for one of four strategies

Heuristic Strategies: Highest Estate Value and Lowest Lifetime Tax

These algorithms will suggest conversions as long as they lead to the stated goal (Highest estate value or lower lifetime tax) and inform you if they do not achieve your strategy goal.

When choosing the highest estate value strategy and the lowest lifetime tax strategy, the Explorer will solve for the stated goal and include all plan elements in the calculation. There is, though, a threshold which limits annual conversions to your plan’s maximum effective tax rate. This means that you may be able to achieve a higher estate value strategy or lower lifetime tax rate manually with your own manual plan or one of the Rule Based strategies.

Rule Based strategies: Tax Bracket Limit and IRMAA Limit

The rule based strategies may result in lower estate value and higher lifetime taxes depending upon the limit you choose and you will not receive a message stating that they could not find a better solution for you, so you may see a negative result depending upon the limit you set.

Additional Details

  • 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 current 401k's may not be converted until you are eligible to withdraw money without a penalty when you have income linked contributions directed to the 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.

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 the source IRA to attain the same results as the Roth Explorer Optimized Plan.

  • If you prefer to convert to your own Roth, you may use the Transfer feature and the tax computation will be the same.

  • Roth Conversions do not satisfy RMD requirements.

  • When modeling conversions, the after tax accounts account(s) will be tapped to cover the taxes as long as available. If you would like to model the tax coming from IRA, you have a couple of options.

    • You may want to exclude the after tax accounts from withdrawals so that pre tax accounts will be tapped to fund taxes once the after tax accounts are depleted. We don't suggest increasing the conversion modeling to account for this.

    • If you wish to leave the after-tax accounts open to pay expenses, you should model the Roth Conversion as a Transfer to a Roth account. And then add a Transfer from the Roth account to a cash account that funds expenses.

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.

You may also want to explore our standalone Roth Conversion Calculator.

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