Why Finding the Optimal Roth Conversion Plan is So Complex
There are seven different lifetime tax reductions arising from Roth conversions. First, there’s the exemption of Roth withdrawals from federal income taxes. Second, Roth withdrawals don’t trigger higher taxation of your Social Security benefits. Third, Roth withdrawals don’t trigger higher Medicare Part B and Part D IRMAA premiums. Fourth, Roth withdrawals aren’t subject to state income taxation. Fifth, Roth withdrawals don’t trigger higher state taxation of your Social Security benefits in states that tax such benefits. Sixth, paying, in the short run, higher taxes out of your regular assets means lower future taxable regular asset income and, therefore, lower taxation of that income. Seventh, lower future taxable regular asset income also means lower future state income taxes.
Figuring out precisely how much to convert each year to minimize your lifetime taxes, taking exact account of these seven tax reductions, is a problem with an infinite number of possible solutions. Say you’re 50 and can live to 100. Then you have 50 potential years left. During each of those years, you can convert whatever amount of tax-deferred assets you’d like, provided you still have such assets left to convert.
Moreover, the longer you wait to convert, the more tax-deferred assets you’ll have available to convert — in part because you’ll earn income on what remains in your regular IRA, 401(k), and other tax-deferred retirement accounts. In addition, as you keep working, you may continue to contribute to tax-deferred accounts. Doing so means even more assets available, over time, for conversion.