Roth Conversion Before Year-End?

It’s that time of year when many of us start fretting about year-end deadlines. Ensuring that impacted clients have taken their RMDs by December 31^st is a big one, but another is completing Roth conversions. I’ve discussed conversions before and the article below will go into more detail, but the concept is a moving target when it comes to retirement strategy and taxes.

Roth conversions sound straightforward – you’re prepaying taxes now on money you’ve saved in your tax deferred accounts like 401(k)s and Traditional IRAs, hopefully at a lower rate than in the future. Sounds simple, right?

But how do you know what your tax rates will be years from now? Do you know what your income will be? How about tax deductions and law changes that might impact your situation? Add the mental gymnastics needed to navigate our tax code and you’ve got a challenging planning landscape. However, there are benefits to converting traditional retirement money into a Roth IRA, so we shouldn’t let complexity dissuade us.

What follows is most of a recent article from Ed Slott, a nationally recognized expert on retirement-related taxes, addressing how recent tax law changes impact Roth conversions. Unsurprisingly, the new law didn’t reduce complexity. There’s a lot of interplay within your tax return and conversions can easily create unanticipated consequences, so don’t make conversion decisions in a vacuum, the author says.

You can and should consult with your tax preparer about this. And I have software that can help, so read on and reach out if you’re interested in getting a Roth conversion done by year-end.

From Ed Slott…

For retirement planning, a key part of the One Big Beautiful Bill is that it permanently extended reduced federal income tax rates enacted in the Tax Cuts and Jobs Act of 2017. Those lower brackets included rates of 10%, 12%, 22%, 24%, 32%, 35% and 37%, all of which were set to expire in 2026. (The rates that prevailed before 2017—and would have prevailed again—were 10%, 15%, 25%, 28%, 33%, 35% and 39.6%).

Of course, “permanence” in tax law lasts only until a future Congress changes the rules. Still, given today’s political situation, it’s likely that the current relatively low tax rates will be in effect through at least 2026 and likely beyond.

So what does this have to do with retirement planning?

The answer lies in the nation’s future liabilities and its debt, especially as the U.S. looks for ways to keep supporting programs such as Social Security and Medicare. Because of those obligations, some observers expect tax rates to rise again sharply in the future, perhaps in a way that affects the high-income taxpayers most likely to use financial advisors and tax professionals.

In particular, there are concerns about people who hold pretax retirement accounts and face required minimum distributions every year once they reach their 70s (the exact start date depends on their year of birth). Hefty withdrawals by that time may be taxed at steep rates.

If current owners do not deplete their tax-deferred accounts, the RMDs will pass to their beneficiaries, who could then owe the resulting tax in addition to their own obligations. Furthermore, the SECURE Act has accelerated those distributions to beneficiaries, which could mean more taxes bunched into more years.

Roths To The Rescue

Roth IRA conversions are an appealing way to trim these deferred taxes, and if the conversions are done prudently, they could keep people’s tax bills in the 24% bracket (or even the 22% one) for as long as the One Big Beautiful Bill is in effect. This year, a married couple could have up to $394,600 in taxable income (after deductions) and owe no more than 24 cents on each taxable dollar. But after a Roth conversion, qualified distributions (including any post-conversion gains) are tax-free for account owners and their beneficiaries. Then the owners don’t face required minimum distributions at any age.

Therefore, a plan that calls for cautious annual Roth conversions, within moderate tax brackets, eventually could reduce or even eliminate RMDs. The trap, though, is that a current Roth conversion must occur during the taxable year (by December 31, 2025, say). That’s a problem, since a person’s exact numbers on their taxable income for that year won’t be known until after that (say, by April 15, 2026) when the return is filed. That means if they want to shift dollars to the Roth side they’ll have to do some guessing with the numbers they know in order to keep their reported income within a desirable bracket.

Creating Complexity

However, the One Big Beautiful Bill also came with tax benefits, which can have a flow-down impact on the taxation of Roth conversions.

One of the most notable changes is the increase in the state and local tax deduction. Since the Tax Cuts and Jobs Act took effect, people who itemize deductions on Schedule A of IRS Form 1040 could deduct only $10,000 for all taxes (income, property, etc.) imposed by states and localities (for both single taxpayers and those filing jointly). Many instead shifted away from itemizing and took the standard deduction.

There’s a case for continued itemizing under the new law, however. For the tax years 2025 through 2029, the SALT deduction rises to $40,000 […]

The combination of tax cuts and Roth conversions sounds like a potent one-two punch. But there’s a catch: The higher SALT limit starts to phase out and goes to 30 cents on the dollar for those whose modified adjusted gross income is $500,000 to $600,000. When MAGI [Modified Adjusted Gross Income] rises above $600,000 or more in 2025, the state and local tax deduction cap reverts back to $10,000 […]

If a taxpayer’s MAGI falls in the phaseout range, though, Roth conversions might create the same sort of “tax torpedo” that happens when IRA withdrawals are added to Social Security benefits—it leads to a spike in marginal tax rates […]

Tackling the Trade-Offs

Beyond the SALT changes, taxpayers may want to consider other provisions of the One Big Beautiful Bill when making Roth conversion decisions. They might, for example, take into account the 20% qualified business income deduction, which also has been made “permanent” for now. For the self-employed individuals and small business owners who qualify for the deduction, the income limits have been expanded.

In 2025, the 20% deduction applies for single filers with taxable income of up to $197,300 or joint filers with income of $394,600. The deduction starts to shrink for the next $50,000 of income (for single filers) or $100,000 (for joint filers). It disappears when singles make $247,300 or joint filers make $494,600. With higher taxable income, there is no qualified business income deduction for certain personal service businesses (which are called “specified service trades or businesses” by the IRS and apply to fields like health, law and accounting) […]

A 20% tax deduction can be appealing, but its availability makes Roth conversion decisions difficult. Such conversions will increase taxable income … and also increase the QBI deduction! But if the Roth conversion puts taxable income over the upper number, the qualified business income deduction might be lost altogether. Fine-tuning is necessary, especially considering that a person’s actual taxable income for 2025 won’t be known until a tax return is filed in 2026.

Yet another innovation of the new law is a $6,000 senior deduction for people age 65 and older (up to $12,000 for married couples) that’s in effect from 2025 through 2028. Again, there is a MAGI phaseout, which runs from $75,000 to $175,000 for singles and from $150,000 to $250,000 for joint filers. Taxpayers who qualify can take the deduction even if they itemize.

With relatively low MAGI limits, Roth conversions might push reported income over the high end of the phaseout range, zeroing out the senior deduction. But people edging out of the phaseout range probably will be in the 22% tax bracket, for a maximum per person tax savings of $1,320 (22% times $6,000). In the long-term, the benefits from a substantial Roth conversion might be worth losing the short-term tax savings.

Final Thoughts

These provisions of the One Big Beautiful Bill must be taken into account for retirement planning, with taxpayers carefully considering the differing MAGI limits and effective dates. Roth conversions are likely to deliver long-term, tax-free benefits. Yet they may result in short-term losses of MAGI-based tax deductions.

The key takeaway is that Roth conversions cannot be done in a vacuum. Taxpayers and their advisors should look at the full array of tax benefits generated by the new law, year after year, and decide how to proceed in order to optimize their overall retirement and estate plans. 

Here’s a link to the full article if you’re interested.

https://www.fa-mag.com/news/how-new-tax-law-affects-roth-iras-84152.html?section=2

Have questions? Ask us. We can help.