Effective tax planning is just as important in retirement as during wealth-building years. For instance, Required Minimum Distributions (RMDs) from traditional individual retirement accounts (IRAs) and 401(k)s can trigger higher tax brackets, increase Medicare premiums, and affect the taxation of Social Security benefits. Roth IRAs have become integral to many Americans’ retirement income and tax strategies to reduce the risk of eroded savings from unexpected tax liabilities. 

As of mid-2024, approximately 26% of U.S. households owned Roth IRAs, highlighting their growing popularity as a retirement planning tool. Unlike traditional retirement accounts, Roth IRAs offer tax-free withdrawals and are not subject to RMDs.  By converting funds from traditional retirement accounts to Roth IRAs, individuals can lock in current tax rates and reduce future tax burdens.

What is a Roth IRA Conversion?

A Roth IRA conversion involves moving assets from a traditional IRA or 401(k) into a Roth account.  While the converted amount is taxed as ordinary income in the year of the conversion, future growth and withdrawals are tax-free, with no RMDs for the account holder.

When Roth Conversions Make Sense

Roth conversions can offer long-term tax savings and estate planning advantages, especially with strategic timing.  Conversions are often most effective:

• During years of lower taxable income (e.g., early retirement years)
• During market downturns (when account values are temporarily lower)
• Before the onset of RMDs at age 73

These “sweet spot” years can help retirees shift taxable funds into Roth IRAs at reduced tax rates, setting the stage for long-term, tax-free income.

Roth IRA Income Limits and the Backdoor Strategy

While there are no restrictions on Roth IRA conversions, according to IRS guidelines, earners above certain income thresholds cannot contribute directly to a Roth IRA.  The 2025 income limits are as follows:

• MAGI of $165,000 or more (single)
• MAGI of $246,000 or more (married filing jointly)

High earners who exceed the limits for direct IRA contributions can use the backdoor Roth IRA strategy to enjoy the same tax-free growth and withdrawals as traditional earners. Here’s how:

STEP 1: Contribute to a Traditional IRA (no income limits apply).

STEP 2: Convert the funds to a Roth IRA, paying taxes on any pre-tax contributions.

The 2025 IRA contribution limits are $7,000 (individuals under 50) and $8,000 (50 or older).  Notably, there is no income limit or cap on Roth conversions themselves.

Why Now Might Be the Right Time

The Tax Cuts and Jobs Act (TCJA), which dictates the current tax laws, is set to expire at the end of 2025.  Without legislative tax changes, tax brackets could revert to pre-2018 levels in 2026, adjusted for inflation. For example, the 2025  24% tax bracket for married couples filing jointly applies to income between $206,701 and $394,600. Before the TCJA in 2017, the closest equivalent—the 25% bracket—applied to income ranging from $75,900 to $153,100, meaning a larger portion of income was taxed at higher rates under the old system.  Since the future of the TCJA is uncertain, 2025 presents an opportunity to evaluate Roth conversions under favorable tax rates.

Reducing Future Tax Liabilities

Roth conversions can lower future RMDs and mitigate upcoming tax obligations by reducing the balance in traditional retirement accounts. The account balance determines the RMD calculation; thus, a smaller balance leads to a smaller mandatory withdrawal, resulting in less taxable income. This can help prevent retirees from being pushed into higher tax brackets due to large RMDs.

Roth IRAs and Estate Planning

From an estate planning standpoint, Roth IRAs offer a unique advantage. Roth IRA beneficiaries inherit the accounts tax-free, unlike traditional IRAs, which require beneficiaries to pay taxes on distributions. This feature can be particularly beneficial for heirs in higher tax brackets because it allows them to receive the full value of the inheritance without tax erosion.  Under the SECURE Act, non-spouse beneficiaries must withdraw inherited funds within 10 years.

Important Considerations

Despite their advantages, Roth conversions are not a fit for everyone.  Here are a few factors to consider.

• Immediate Tax Impact: The converted amount is taxed in the year of the conversion, which may affect an individual’s tax bracket that year.
• Impact on Benefits: Higher taxable income could increase Medicare premiums and Social Security taxation due to Income-Related Monthly Adjustment Amounts (IRMAA). IRMAA assigns higher premiums to those who exceed established income thresholds.
• Liquidity Needs: Individuals should consider paying conversion taxes from non-retirement assets to avoid reducing their investment base.
• Market Conditions: Converting assets during market highs may result in paying taxes on values that later decline.

Roth IRAs provide flexibility, control, and peace of mind in retirement, plus tax-free withdrawals.  With the right strategy, Roth conversions can help individuals avoid future tax surprises, reduce RMD exposure, and leave a tax-efficient legacy for loved ones.

At SHP Financial, we help clients evaluate if and when a Roth conversion fits their broader financial goals.  If you’re curious about how this strategy could enhance your retirement plan, reach out for a complimentary review of your finances.  Together, we’ll determine whether a Roth conversion can help you keep more of what you’ve earned for a stronger financial future.

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