Balancing your tax decisions while maximizing your potential for retirement wealth is essential. This guide brings together the strategies we use daily at our firm during our Hourly Financial Planning sessions, which have allowed our clients to establish legal strategies to save thousands of dollars in taxes and optimize their portfolios.
01. Fundamentals and Why to Consider Roth Conversions
To understand the present, we must look back. According to the Investment Company Institute, as of December 2024, traditional 401(k) plans have accumulated assets exceeding $8.9 trillion. These plans have been the preferred mechanism for Baby Boomers (born between 1946 and 1964) to save for retirement since Ted Benna designed the first plan in 1980.
Since its inception, the value proposition of the 401(k) has been: don’t worry about taxes now; instead, start saving, reduce your taxes with the contributions you make to your plan, and let that money grow by taking advantage of the effect of compound interest over time. The “deal” is that when you retire and start making withdrawals, you will have to pay taxes.
Many thought that in retirement, their tax bracket would be much lower because they wouldn’t have income from their jobs and would pay significantly fewer taxes when withdrawing money from their 401(k). However, we often see 80-year-olds paying more taxes than when they were working, despite having no employment income. The answer to this phenomenon is called RMD: Required Minimum Distribution.
The Impact of RMDs and the Secure ACT 2.0
After so many years of letting your money grow, the IRS (your primary partner in the retirement plan) wants its fair share and forces you to take withdrawals from your traditional plans, even if you don’t need them. If you’ve been a diligent saver and have a separate pension, you might prefer these accounts to keep growing tax-free, but the IRS has other plans.
With the Secure ACT 2.0, the RMD starting age improved substantially:
- For those who turned 72 after December 31, 2022, the starting age is 73.
- For those born in 1960 or later, the starting age is 75.
While this allows money to grow longer, it also drastically increases the likelihood of finding yourself in an extremely high tax bracket starting at age 75.
How are RMDs calculated?
Upon reaching eligibility age, you must total the December 31 balance of all your tax-deferred accounts, including:
- Traditional 401(k).
- Traditional IRA, SEP IRA, and SIMPLE IRA.
- 403(b) and 457(b) plans.
- Profit Sharing and other defined contribution plans.
Then, you divide that sum by an IRS factor (based on the Uniform Lifetime Table). The problem is that every year that factor decreases, forcing you to withdraw larger and larger portions of your balance.
Practical Example: If your plan balance is $3,000,000 and you are 73, your factor is 26.5. Your RMD would be $113,208. If the market grows and your balance stays at $3,000,000 the following year (age 74), the factor drops to 25.5, forcing a withdrawal of $117,647. By age 80, with that same balance, the factor would be 20.2, resulting in a forced withdrawal of approximately $148,515. This constant increase can push you into much higher tax brackets than anticipated.
02. Why Not Simply Save in Roth Accounts?
It is natural to ask: “Why don’t I save more in a Roth 401(k) or Roth IRA?”. These accounts grow tax-free and do not require RMDs. However, they have significant limitations:
- Contribution Limits: In 2025, the maximum for a Roth IRA is only $7,000.
- Income Limits: If you file jointly and earn more than $246,000 (in 2025), you cannot contribute directly to a Roth IRA.
- The Current Tax Dilemma: For those in their peak earning years, their current tax bracket may be so high that making Roth contributions now doesn’t make sense, as they would lose the immediate tax savings offered by deducting traditional 401(k) contributions.
This is where Roth Conversions appear as the true solution and the “perfect marriage” for RMDs.
03. When to Consider (and When NOT to) a Roth Conversion
A Roth conversion is the process of transferring assets from a traditional 401(k) or IRA to a Roth IRA account. In doing so, you pay income taxes on the amount transferred today, so that money grows tax-free and RMD-free forever.
When It Makes Sense: The “Tax Optimization Valley”
The ideal time to convert is when your tax rate is lower than projected for the future. During your working years, you are usually in a high bracket, but when you stop working, your rate drops substantially. This period, before RMDs and Social Security begin, is the “Tax Optimization Valley.” Converting during these years allows you to reduce the base of your future RMDs by paying taxes at a much more comfortable rate.
When It Is NOT Advisable:
Despite their benefits, conversions are not a “magic bullet” for everyone. You should not consider a conversion if:
- Similar or Lower Projected Rates: If your current tax rate is equal to or higher than what you expect in the future, the logical benefit of the conversion is lost.
- Liquidity Needs: If you depend on your RMDs for living expenses, incurring an additional tax liability on that money is not advisable.
- Short Life Expectancy: The benefits of tax-free growth require time. If you don’t expect to enjoy those benefits long-term, you would be paying taxes today for something you won’t fully utilize.
- ACA Subsidies: If you are under 65 and depend on health subsidies, a conversion increases your Adjusted Gross Income (AGI), which could reduce or eliminate your health insurance subsidies.
04. RMD and Roth Conversion: The Strategy for Active Investors
If you are already in the stage of receiving RMDs but do not need that money to live, there is a strategic opportunity. The IRS requires those funds to be withdrawn and reported as income. However, you can choose to withdraw an additional amount (above your RMD) to perform a Roth conversion.
The key to success here is withdrawing just the right amount to stay within your current tax bracket (for example, the 24% bracket) without jumping to the next level. This allows you to move assets into a tax-free environment while maintaining control over your annual tax bill.
05. Beyond Taxes: Other Benefits
The strategy offers advantages that impact your financial and emotional well-being:
- Income Flexibility: In retirement, your needs fluctuate. A Roth IRA gives you access to tax-free funds for unexpected expenses or special trips without affecting your tax bill.
- Protection Against Tax Increases: Given the growing public debt, many experts believe tax rates will rise in the future. By converting today, you “lock in” your current rate and protect your purchasing power.
- Peace of Mind: It eliminates the stress of constantly planning how forced withdrawals will affect your taxes or if they will push you into higher Medicare (IRMAA) brackets.
- Legacy and Inheritance: There is no better way to leave an inheritance than a Roth IRA. Unlike a traditional 401(k), where beneficiaries must withdraw the money and pay taxes within 10 years (often during their own peak earning years), the Roth IRA gives them a tax-free estate that can continue to grow for that additional decade.
06. Is This Strategy Right for You?
Retirement planning is a comprehensive process that goes beyond accumulating savings; it’s about ensuring stability by minimizing the impact of taxes. A thoughtfully executed Roth conversion can safeguard your capital and provide a secure, worry-free retirement.
To determine the ideal amount to convert, a personalized analysis is essential, considering your goals, cash flow, and life expectancy. At Advise Financial, we use specialized software to simulate these scenarios and find the perfect balance for each case.
Don’t allow taxes to dictate the outcome of your retirement. With the right strategies, you can maximize your wealth and ensure your money works in your favor, allowing you to enjoy these years to the fullest without financial worries.
Conclusion: The Advantage of Independent “Fee-Only” Planning
As independent financial planners, our priority when performing Roth Conversions is to optimize your taxes so that your wealth continues to grow and you can have a better retirement and achieve greater financial well-being for yourself, transforming your finances to transform your life.
If you reside in the Boca Raton area or in Palm Beach County and want a technical second opinion on your retirement strategy, we invite you to review your tax projections with us. The best time to plan for RMDs is not at age 73, but today.
If you’re looking for a review of your tax strategy or portfolio, or a second opinion, schedule your first complimentary consultation today. To ensure the highest level of service for our clients, our office does not accept walk-ins.
Educational Purpose Only – Not Tax Advice
Contact for Retirement Analysis: www.advise-financial.com | info@advise-financial.com | (561) 454-8284.
