Considering A Roth Conversion? Here’s The Catch.

There’s a moment that catches a lot of people off guard in retirement. You spent decades saving, doing everything right, and then somewhere in your 70s the IRS tells you it’s time to start taking money out of your retirement accounts whether you need it or not. They’re called Required Minimum Distributions, and the bigger your account has grown, the more they make you withdraw, and the more you withdraw, the more you owe. Between RMDs, Social Security, and whatever other income you have, you could easily find yourself in the 24% bracket or higher, paying more in taxes than you ever expected to on money you didn’t even want to withdraw. It feels like you’re being punished for saving well, and in a way, you are.

That’s where Roth conversions come in. The idea is simple: each year, you move a portion of your traditional IRA or 401(k) into a Roth IRA, pay income taxes on that portion now at a lower rate, and let the money seek potential tax-free growth for the rest of your life. You do it gradually so you can fill up the lower income tax brackets each year without spiking into the higher ones. When done well, the savings over a lifetime could potentially be hundreds of thousands of dollars. It’s one of the most powerful tools in retirement planning, and on the surface, it sounds like a no-brainer.

But most of the conversation around Roth conversions focuses entirely on federal income tax brackets, and that’s only one piece of the puzzle. If you’re not paying attention to the other pieces, you could end up paying thousands of extra dollars a year without even knowing it.

One of those pieces is something called IRMAA, which stands for Income-Related Monthly Adjustment Amount. It’s a surcharge on your Medicare premiums that kicks in once your income crosses certain thresholds, and the way it’s calculated is different from how your income taxes are calculated. So your accountant might tell you to convert up to the top of the 22% tax bracket, and based on one set of numbers it looks like you’re in the clear. The problem is that the IRS and Medicare are looking at two different versions of your income. Your tax bracket is based on your income after deductions, but Medicare bases its surcharges on your income before deductions. Think of it like two different speed limits on the same road. You might be under one of them, but you’re over the other one and you don’t even know it. And Medicare isn’t forgiving about it either. Cross their line by even a dollar and your premiums can jump by thousands of dollars a year depending on how far over you go.

I recently walked through this exact scenario with a couple, let’s call them Herb and Mindy. They had substantial pre-tax retirement accounts, a solid Roth conversion plan, and were feeling good about it. They’d done their homework, talked to their accountant, and felt like they had it figured out. Their strategy was to fill up the 22% bracket every year for several years, which on paper would save them close to a million dollars in federal income taxes over the course of their retirement. But when we looked more closely and factored in the IRMAA surcharges they’d be triggering along the way, they were giving back over $5,000 a year in extra Medicare premiums they didn’t need to be paying. That’s the kind of thing that’s hard to catch if you’re only looking at one scoreboard, and most people, even most advisors, are only looking at one scoreboard.

The fix wasn’t complicated. Instead of converting all the way up to the top of the 22% bracket, we adjusted the strategy so they converted up to just below the IRMAA threshold. They ended up converting a little less each year, which actually felt better because it meant paying less in taxes upfront, and the long-term result was tens of thousands of dollars in savings over the course of their retirement. Less pain in the short term and more money in the long term, just from knowing where the landmines are.

And IRMAA isn’t the only thing to watch for. Roth conversions can also affect how your capital gains are taxed and how much of your Social Security becomes taxable. The point is that a conversion doesn’t just show up on one line of your tax return. It has ripple effects across your entire financial picture, and if you’re only looking at the income tax bracket, you’re not seeing the whole thing.

Roth conversions are supposed to give you back control over your taxes, that’s the whole point. But if the strategy isn’t done with the full picture in mind, you’re just trading one problem for another. The difference between a good plan and a great one often comes down to these details, and getting them right could easily be worth tens of thousands of dollars over the course of your retirement. n

Jack Strulowitz is a Financial Advisor at Bernath & Rosenberg in Cedarhurst, NY, where he helps high-net worth individuals and families manage their investments and build comprehensive strategies for retirement, tax, and estate planning. For questions or to schedule a consultation, please contact [email protected] or 847-962-3352.

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.

Securities and advisory services offered through LPL Financial, a registered investment advisor, member FINRA/SIPC.

This information is not intended to be a substitute for individualized tax advice. We suggest that you discuss your specific tax situation with a qualified tax advisor.

A Roth IRA offers tax deferral on any earnings in the account. Qualified withdrawals of earnings from the account are tax-free. Withdrawals of earnings prior to age 59 ½ or prior to the account being opened for 5 years, whichever is later, may result in a 10% IRS penalty tax. Limitations and restrictions may apply.

Traditional IRA account owners have considerations to make before performing a Roth IRA conversion. These primarily include income tax consequences on the converted amount in the year of conversion, withdrawal limitations from a Roth IRA, and income limitations for future contributions to a Roth IRA. In addition, if you are required to take a required minimum distribution (RMD) in the year you convert, you must do so before converting to a Roth IRA.