Your income drops. Your tax bracket falls. Suddenly, a Roth conversion looks like the obvious next move.
That’s a familiar recommendation for people retiring early or stepping back from full-time work. Move money from a traditional IRA into a Roth IRA, pay the tax now, and position yourself for tax-free qualified withdrawals later.
If the tax rate on those dollars is lower today than it would be when you otherwise withdraw them, the strategy can make sense.
But a lower tax bracket doesn’t automatically make this the right time—or tell you the right amount—to convert.
Before you voluntarily send the IRS a check, consider what else that decision could cost.
Imagine a hypothetical couple, both 55, leaving their full-time jobs. They’ve accumulated substantial retirement savings, along with cash and brokerage investments to help cover the years before Social Security and other retirement income begin.
With their salaries gone, their taxable income falls. They’re also purchasing health insurance through the Marketplace until they become eligible for Medicare.
A Roth conversion looks attractive. But their lower income and accessible savings are already doing several important jobs.
Their low income helps keep health insurance affordable.
Marketplace premium assistance depends on household income. A taxable Roth conversion increases that income, even though the couple hasn’t received additional money to spend.
Depending on their circumstances, converting could reduce or eliminate their premium assistance.
That means the conversion’s cost may include both the income-tax bill and higher health insurance expenses.
This doesn’t automatically make converting a mistake. The future benefits might justify those costs. But “we have room in a lower tax bracket” doesn’t answer the whole question.
A low tax bracket and a low-cost conversion aren’t necessarily the same thing.
Their cash reserves are funding their retirement transition.
The couple plans to pay the conversion tax from savings outside their IRA. That can preserve more money inside the Roth, where future qualified withdrawals would be tax-free.
But suppose the estimated tax bill is $25,000.
Those dollars were also available for mortgage payments, groceries, insurance premiums, home repairs, and unexpected expenses. Once used to pay conversion taxes, they’re no longer available for those purposes.
The couple may improve their projected financial position decades from now while making the next several years harder to navigate.
Having enough cash to write the check isn’t the same as having enough cash left afterward.
That matters especially early in retirement, when spending patterns are still taking shape and an unexpected expense can disrupt a carefully constructed plan.
They may need the converted money sooner than expected.
Suppose their remaining accessible savings run short.
They might assume that because they’ve already paid tax on the conversion, they can freely withdraw those converted dollars whenever necessary.
At 55, that assumption can be expensive.
Withdrawals that reach recently converted pretax dollars before age 59½ and within the conversion’s five-tax-year period can trigger a 10% additional tax unless an exception applies. Existing Roth contributions and older conversions can affect the result because withdrawals follow specific ordering rules.
This isn’t a blanket five-year lockup on every Roth dollar. But it is a reason to identify which assets will fund near-term spending before moving money.
A conversion intended to improve retirement shouldn’t leave someone scrambling to finance it.
The answer for this couple might be a smaller conversion. It might be spreading conversions across several years or waiting until their spending and insurance costs become clearer.
Early retirement can still provide an excellent conversion opportunity. The goal is to use that opportunity without sacrificing the resources that make retirement workable today.
Before converting, ask: How will this affect my health insurance? Where will the tax payment come from? What money will remain available for planned spending and surprises?
“Roth conversions can be smart” is a starting point. A recommendation should explain why this conversion, in this amount, at this time, supports your life.
At Hanover Advisors, we evaluate Roth conversions within your broader retirement plan, including taxes, healthcare costs, spending needs, and financial flexibility. If you’re retiring early or considering a conversion, let’s discuss an approach that supports both your future goals and the retirement you’re living today.