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Fill up a Tax Bracket When Converting to a Roth IRA

Doug Carey, CFA

Key Points:

  • Converting to a Roth IRA can save some people thousands of dollars over time.
  • Using rules of thumb for such a serious undertaking is not a good idea. You need accurate financial planning software to do this.
  • The best way to optimize your Roth conversions is to find the optimal tax bracket to “fill up”.

Planning a Roth conversion can be like playing chess. When played right, it can help set you up for a comfortable and tax-free retirement income. But when is the right time to make this move?

Many people decide to convert to a Roth IRA once they retire and their taxable income declines substantially. It’s even more valuable if they do this before Social Security benefits begin since Social Security can add to taxable income, reducing the amount that can be converted at favorable tax rates.

Another reason some people convert to a Roth IRA is that they believe income tax rates will increase in the future. In such a case, paying taxes now at a lower rate and securing a tax-free retirement income could be a smart move.

A Roth conversion involves taking money out of your traditional IRA, paying taxes on it now, and then moving it into a Roth IRA where it grows tax-free for the rest of your life. If you're in a lower tax bracket, the tax hit you'll take on the converted amount would be less severe.

But remember, like any financial strategy, a Roth conversion isn't one-size-fits-all. It's important to weigh the benefits against potential downsides. The easiest and most accurate way to do this is to run Roth conversion scenarios in WealthTrace. Sign up for a free trial here to get started. WealthTrace customers can even use a financial planning expert to guide them in this decision.

In the end, it's all about looking at your current situation, considering your future prospects, and making an informed decision. So, what do you think? Could a Roth conversion be your next strategic move towards a secure retirement?

Filling Up Tax Brackets

As you think about whether or not a Roth IRA conversion makes sense for you, one approach worth considering is the 'fill up the bracket' method. This tactic involves assessing your income level and corresponding tax bracket, then converting an amount from your IRA or qualified retirement plan (like a 401k), sufficient to use the remaining portion of your current tax rate bracket.

This strategy is typically more beneficial for those in the lower brackets, but it might also be suitable for high earners under certain circumstances. Your stance on this largely depends on your predictions regarding future tax rates as you approach retirement. If you're of the opinion that tax rates are set to increase, then this could be the right strategy.

To illustrate how this works, consider this table showing the maximum income allowed within each tax bracket in 2023.

Federal Income Tax Brackets

The figures are based on the rates for a single taxpayer and a married taxpayer, using only the standard deduction. If your deductions exceed the standard deduction ($13,850 for singles, $27,700 for married couples), add the difference. If you're 65 or older, add $1,850 if you're single, or $1,500 for each spouse who is 65 or older.

Let's look at an example. Suppose you're single with no dependents and your annual income is $30,000. According to the table, you fall into the 12% bracket. The highest gross income in this bracket is $44,725, meaning you could convert up to $14,725 to a Roth IRA and remain within the 12% bracket, without pushing yourself into a higher tax bracket. The federal tax on this conversion would be $1,767.

As another example, suppose you're married with a household income of $40,000. According to the table, you fall into the 12% bracket, with the upper limit being $89,450. To fill up the bracket, you could convert as much as $44,450 without exceeding the 12% bracket. The federal tax on this conversion would be 12%, or $5,334.

You can run these scenarios in the WealthTrace Retirement Planner where you specify which tax bracket you want to stay under.

Fill up tax bracket when converting to a Roth IRA

WealthTrace will convert the amount each year until you just reach the tax bracket limit you set. You can then view how much to convert in each year and how much money will be left at the end of the plan in the base case and the conversion scenario.

Roth conversion scenario results when filling up a tax bracket


You can view projections such as total taxes paid, tax rates, investment balances, income for IRMAA, and overall taxable income in the base case and the conversion scenario.

Fill up tax bracket when converting to a Roth IRA


Other Factors

There are other factors that go into the Roth conversion decision. If you plan on converting to a Roth IRA, you might want to delay taking Social Security to age 70 in order to maximize the amount you can convert before jumping into another tax bracket. Taking a part-time job can also impact the Roth conversion decision since this too will increase your income and decrease how much you can convert before you hit a higher tax bracket.

Bottom Line

In the intricate process of financial planning, a Roth conversion can save you thousands of dollars and allow you to withdraw money tax-free in retirement. Timing is key, with retirees often capitalizing on reduced taxable income and the opportunity to shield their assets from Social Security's tax impact.

By adopting the 'fill up the bracket' method, individuals can optimize a Roth conversion, carefully considering their income level and the corresponding tax bracket. While particularly advantageous for lower-income earners, high earners may also find value in this approach.

Tools like WealthTrace can help you make a more informed decision. Ultimately, your financial future hinges on a comprehensive evaluation of your current circumstances, future prospects, and thoughtful planning. So, could a Roth conversion be your next strategic move towards a secure retirement?

Are you leaving money on the table if you don’t convert to a Roth IRA? To find out, sign up for a free trial of WealthTrace and run Roth conversion scenarios today.

Do you want free tips on how to retire early? How about retiring stress-free? Learn how to make sure you do not outlive your money by signing up for our free articles.

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Doug Carey, CFA