The Roth Conversion Dilemma
When it comes to Roth conversions, opinions are divided. Some advisors recommend converting traditional retirement accounts into Roth IRAs as soon as possible, while others insist it’s rarely a good idea. The truth lies somewhere in between—and the right choice depends heavily on your personal financial situation.
For retirees who have both a pension and more than $1 million in savings—sometimes referred to as the “2% club” because such cases are relatively rare—the math behind Roth conversions looks very different from the average retiree. These individuals often have higher income and higher lifetime tax exposure, which means traditional tax advice may not apply to them.
Why Roth Conversions Matter More for Pension Holders
A Roth conversion involves moving money from a tax-deferred account (like a traditional IRA or 401(k)) to a Roth IRA, where it can grow tax-free. You pay taxes on the amount converted today, but withdrawals in retirement are tax-free.
For retirees with pensions, this move can be particularly valuable because pensions create guaranteed taxable income. Combined with required minimum distributions (RMDs) and Social Security, this can push retirees into higher tax brackets during retirement—sometimes even higher than when they were working.
That constant taxable income also affects other areas, including:
- Social Security taxation – Higher income can cause up to 85% of benefits to become taxable.
- Medicare premiums – Income-based surcharges (IRMAA) can increase costs significantly.
- Widow’s penalty – When one spouse passes away, the surviving spouse’s tax brackets effectively shrink, often resulting in higher taxes on the same income.
A Roth conversion can help mitigate these effects by shifting future growth into tax-free territory while rates are still favorable.
When Roth Conversions Might Not Make Sense
Not everyone in this group should rush to convert. For example, if your goal is to leave most of your assets to charity, Roth conversions may not offer much benefit, since charitable donations from IRAs can already be made tax-free through qualified charitable distributions (QCDs).
Similarly, if you expect your taxable income to drop significantly later in life, paying conversion taxes now could cost more than waiting.
The key is to understand where your future income will come from—and how it interacts with the tax code.
Understanding the Tax Mechanics
A typical retiree without a pension might rely solely on savings and Social Security. Thanks to the standard deduction (roughly $30,000 for married couples filing jointly), they may owe little or no federal income tax.
However, a retiree with both a pension and significant savings could easily see their income exceed that threshold. Even a modest $30,000 pension could fully consume the deduction, making all additional income—such as RMDs or investment withdrawals—taxable.
This structure often leads to what’s called the “Social Security tax torpedo”, where small increases in income can cause large portions of Social Security benefits to become taxable, effectively raising the retiree’s marginal tax rate well beyond the stated bracket.
The Hidden Value of Planning Ahead
Because pensions act like a form of tax-deferred income, they can compound the problem over time. Someone with $2 million in tax-deferred accounts today could see that grow to $5 million by their early 70s. At that point, RMDs alone could force out more than $200,000 per year in taxable withdrawals—whether they need the money or not.
Roth conversions before that point can prevent the issue from snowballing. By strategically converting portions of an IRA each year—often up to the top of the 22% or 24% tax bracket—retirees can spread out the tax burden and reduce future RMDs. This not only controls taxes but also offers flexibility in managing income later in life.
Protecting Your Spouse and Legacy
Roth conversions also serve an important role in estate planning. After one spouse passes away, the survivor files taxes as a single individual, cutting the income thresholds in half. A pension that once fit comfortably in a joint tax bracket may now cause a jump into higher brackets for the surviving spouse.
Converting to a Roth while both spouses are alive can reduce that risk, ensuring the survivor inherits more tax-efficient income sources. Additionally, heirs who inherit Roth accounts can withdraw funds tax-free—unlike traditional IRAs, which must be emptied within 10 years and are fully taxable.
Finding the Right Balance
The question is not whether to do a Roth conversion, but how much and when. Converting too much in one year can trigger unnecessarily high taxes or Medicare surcharges. Converting too little may leave large future tax burdens untouched.
A thoughtful, multi-year strategy—adjusted for expected income, age, and health—can help strike the right balance. Many retirees aim to convert up to the top of a specific tax bracket each year to optimize long-term results.
The Bottom Line
Roth conversions are not a one-size-fits-all solution. But for retirees with pensions and high savings, they can be one of the most powerful tools to manage lifetime taxes, protect a surviving spouse, and leave a tax-efficient legacy.
The key lies in planning ahead, modeling future tax scenarios, and ensuring that today’s tax decisions align with tomorrow’s goals.
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