4 cases when a Roth conversion won't pay off for you

Yahoo

22-05-2025

If you're eager to jump on the Roth bandwagon, it may be frustrating to go through the process and find roadblocks. But sometimes, you run the math and it just doesn't make sense for you.
Roth IRA conversions are not a good idea for everyone. They work in certain circumstances where the tax arbitrage comes out in favor of paying the tax now rather than paying it later. It's not simple math, and it involves a lot of guesswork about the future, plus it requires a lot of cash on hand. And the transactions can be tricky — paperwork and strict timetables are involved.
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'It's like French cooking,' financial planner Thomas Duffy said. 'There are so many difficult techniques to master.' MarketWatch spoke with Duffy, who is based in New Jersey, as he was preparing for a call about Roth conversions with a client for whom there were a slew of considerations.
The client is 68 and just retired. He wants to continue working part-time and start collecting Social Security. His spouse is still working. Duffy wanted to convince him to wait two more years, until he turns 70, to claim Social Security, and in the meantime to convert some significant IRA money to a Roth using a stash of $200,000 in cash to cover the tax bills. 'I will tell him that his tax bill for this year will be close to the 12% bracket, but once his spouse retires and they start taking required minimum distributions, they'll be at least in the 24% bracket,' Duffy said.
Doing Roth conversions for a few years now could save that couple 2% on their taxes in later years.
But Duffy has other clients for whom the math doesn't make sense. And whenever I write an article about Roth conversions — which entail taking money out of a tax-deferred account like a 401(k) or IRA, paying the tax on the income and then moving the money to a Roth account — I get lots of letters from people outlining their circumstances and then asking why the conversion won't work out for them, or why their adviser is telling them not to do it. Here are four cases where readers ran into obstacles to making the Roth conversion strategy work for them.
Reader No. 1 wrote: 'I'm 66 and hope to work another year or two. I currently have a rollover IRA of $725,000 managed by an adviser and another $250,000 rollover IRA that I manage. I also opened a Roth IRA three years ago and have approximately $25,000 in it via direct contributions and no rollovers. I have approximately $50,000 in money-market accounts and $40,000 in gold and silver coins. I am trying to determine the best solution for rolling over money from my IRAs to my Roth account over the coming years.'
The case against a Roth: This person, who is 66 and has about $1 million saved, doesn't appear to have enough cash on hand to make it worthwhile to do a Roth conversion. They would need cash to pay the extra tax. If they take that payment out of the conversion itself, they'd miss out on part of the value, in that they would be converting $80 out of $100 instead of the whole $100. They could just leave the money in the IRA universe and pay the tax as money is disbursed each year, or they could wait until they have greater cash savings.
The other reason to stall on a Roth conversion is that Reader No. 1 is still working and is probably in a relatively high tax bracket. Ideally, you do Roth conversions after you retire, when your income is lower, and pay at the lowest tax bracket you can.
Reader No. 2 wrote: 'I recently turned 68 and want to retire next year at 69. I expect to have roughly $1.2 million in my Employee Stock Ownership Plan account, which will need to be transferred into a standard 401(k) upon my separation from the company. I also have a state employee pension of roughly $100,000 per year, gross. What I am trying to understand is how to utilize a Roth conversion for the 401(k). I have a significant mortgage, as my wife and I executed on our dream of living in California wine country. Other than that, I have no debt and apparently now qualify for full Social Security benefits due to the recent change in the law. Does a Roth conversion strategy apply, and can it help me?'
The case against a Roth: Like Reader No. 1, this reader has a lot saved, is still working and is in a high tax bracket. They are a few years older, so they have even less time to take advantage of conversions before they start having to take required minimum distributions. Plus, once they retire, they will be on Medicare, and their income will likely be high enough to cancel out any tax savings they'd get from doing conversions. You want to make the most use you can of the years before age 63 to avoid those IRMAA surcharges.
Reader No. 3 wrote: 'I have about $300,000 in an IRA. I'm 79 years old and want to pay the least tax possible. I am currently taking my RMDs but want to convert to a Roth IRA and give some money to my college-bound granddaughter. Does a school savings account qualify as a qualified charitable distribution?'
The case against a Roth: There's a strategy where you can use direct charitable contributions to offset your RMDs and thereby maximize the tax efficiency of a Roth conversion. However, the account balance for this grandparent is probably not enough to worry about doing a Roth conversion, and giving money to their granddaughter for school won't count as a charitable contribution for the purposes of their RMD.
The only way that contributing to a 529 would help this reader with their taxes is if their state gives a deduction for it, or if they have an estate over $13.99 million and need to give away some money to avoid estate taxes. With $300,000 in their IRA, this reader's required minimum distribution is around $14,000. That's not likely to affect their income-tax bracket very much, but that would depend on their other holdings. They may be better off leaving that money in the IRA and having it available to pay for long-term-care costs, should those be needed.
Reader No. 4 wrote: 'I'm 53 with almost $2 million combined in my 401(k) and Roth IRA. Should I consider a Roth conversion anytime soon?'
The case against a Roth: The answer to this really depends on the ratio of what's in the 401(k) and the Roth. I'm going to assume that it's at least an even split, which means this reader has $1 million at a young age in a tax-deferred account, which could grow to more than $4 million by the time they reach 75, the age they would need to start taking RMDs under current regulations. That's going to mean a huge RMD, and they might want to do something about that now. But if they're still working and they've saved that much already, they're likely already in the 32% or 37% tax bracket.
If that's the case, they might want to wait until they stop working and their tax rate goes down to 12% or 22%. That said, sometimes people expect their tax rates to drop in retirement and they never do. If that is the case, they'll have to decide when they want to pay the tax on their savings, which could either be a phased conversion strategy, a giving strategy or doing nothing at all and just paying as they go.
One thing this reader can do in the meantime is stop contributing to tax-deferred accounts and switch to a Roth 401(k). With that, they'll pay their working tax rate as they go but won't run into bigger problems down the road with conversions.
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