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January 08, 2019 at 10:30 AM
(Image: Thinkstock)
Welcome to Hidden Value, the column where Joe Elsasser, CFP, addresses common financial planning issues with insights advisors and their clients may not have considered.
Q. How much should my client convert to a Roth?
A. The tax overhaul passed in 2017 significantly lowered marginal income tax rates for most people, and many advisors are now evaluating Roth conversions for their clients. However, while it seems like the deliberation is whether or not to convert the entirety of an IRA balance to a Roth, I would suggest the right question is “how much should I convert to Roth?” And don’t forget the related question: “How much is too much?”
Considerations for Roth conversions are often made from a single-year viewpoint. It is most common to consider Roth conversions when a client is at the edge of a tax bracket. For example, a client in the middle of the 12% tax bracket may want to consider converting enough IRA to Roth IRA to fill the 12% bracket, but avoid any withdrawals being taxed at 22%. Because the jump from 12% to 22% is so significant, it’s unlikely a client would want to convert his or her entire IRA.
For other clients who are likely to be in the 22% or 24% bracket for the rest of their lives, converting to the top of the 24% bracket may make sense, since the next bracket is a full 8% higher rate, at 32%. The tax brackets of the client’s children will often be a key consideration for this group.
An additional wrinkle when considering conversions for higher income people is Medicare. If they are within two years of Medicare or already over 65 years old, then it is worth considering conversions to the point the client would pay additional Medicare part B and D surcharges, which are not calculated as tax directly, but are based on modified adjusted gross income. Quantifying the single-year impact of various conversion strategies enables a client to make an educated decision about the costs of a conversion and avoid potential pitfalls like entering a new bracket or creating unnecessary Medicare expenses.
