Candace Lee, CFP®, EA

Candace Lee, CFP®, EA

Candace’s approach to working with clients is very personal. Getting to know a family and listening to their unique stories allows her to build a stronger relationship and deeper understanding of their situation. Combining this empathy and desire to help others with her passion for financial planning, Candace is able to help families reach their financial goals as a Vice President and Client Advisor at Glassman Wealth.

Why You Should “Roth” During Your “Trough”

Some of our clients love what they do and could see themselves working well into their 70s. Others want to retire as soon as financially possible. If you are in the latter group and either have already retired or are preparing to slow down, keep reading. There is a retirement and tax planning strategy that may make sense for you and your family to consider in your trough years. Moving funds from a traditional IRA to a Roth IRA account while you’re in a lower tax bracket can allow you to lock in a lower tax rate and help save you money.

Uhhh…What are “Trough” Years?

Also known as income gap years, “trough years” are the years after you (and/or your spouse/partner if you have one) stop working, but before taking social security or retirement account required minimum distributions. This transitionary period could lead to substantially reduced income for several years.

Why is this significant from a tax perspective?

The general rule of thumb in higher income or peak years (like when you are working), is to accelerate deductions to try to lower your tax bracket (think charitable donations, Roth IRA max contribution or retirement deferrals). This is what many investors prioritize and it’s a great strategy except when it comes time to withdraw these funds, they are often back at top tax brackets (and it’s even worse when there are no other taxable assets to draw from when there is a cash need—ouch!). Roth IRA withdrawal penalties are highest at this time.

Depending on the timing of retirement and the timing of other income sources (like pensions, social security income, and IRA distributions), you may have several years where you are in a much lower tax bracket. In those lower income years, you may want to accelerate income to fill up lower tax brackets. By converting some of these pre-tax dollars to after-tax dollars, you have the potential to lock in a lower tax rate and thus reduce your overall tax rate in the future without facing a Roth IRA withdrawal penalty.

Let’s See It in Action

Below is a case study to demonstrate this strategy and how it can be used to lower your overall tax due during the trough years:

Bill and Jill are married and have retired this year at the age of 60. They have two children who are high earners and they themselves live modestly and don’t need the portfolio to meet their lifestyle needs. They have no debt, take the standard deduction (currently $25,900 as of 2022), and have a large capital loss carryforward that helps them offset annual capital gain distributions. After completing a net worth statement, they listed the following income and assets:

  • Joint Assets: $1,150,000
  • Pre-Tax (retirement) Assets: $850,000
  • Bill’s Pension: $2,000/month ($24,000/year)

Keep in mind some key retirement dates:

  • At age 65, they become eligible for Medicare (however, modified adjusted gross income is used to determine Medicare premiums starting two years before this age)
  • At age 70, they plan to take their social security benefit (let’s assume it’s $40,000/year for each of them)
  • At age 72, they would need to begin taking their Required Minimum Distributions (RMDs) from their retirement accounts. If nothing is converted, we can assume RMDs will be north of $150,000/year (assuming an annualized 5% growht rate over a 12-year time period).

Between the ages of 60 (when they retire) and 70 (when they first state taking social security), if they do nothing, there are at least 10 years where they could be in a 0% tax bracket. However, starting at 72, they would be catapulted into the 22% tax bracket for the rest of their lives assuming nothing changes with the tax code between now and then. If they live until age 92, that’s 20 years at the higher tax rate.

If instead, Bill and Jill look to convert ~$80,000/year from their IRA to a Roth IRA in these 10 years, they’ve taken advantage of a 12% marginal rate versus waiting until RMD age and subjecting more income to a 22% rate. They have also lowered their tax rate in the future by reducing the amount that would ultimately be required to be withdrawn from their IRAs. They could potentially stay in the 12% marginal tax bracket from 60-92 (32 years) using this strategy. (For illustration purposes, we are blindly assuming the tax rates don’t change in the future.)

Why else should this strategy be considered?

There are a few additional reasons to consider this strategy:

There will likely be higher rates in the future: At least as of today, tax brackets are historically low. Based on the Tax Cuts and Jobs Act passed in 2017, tax brackets are expected to go back to their higher levels beginning in 2026; so even if you decide to do nothing, tax brackets are slated to go higher.

You want to pass assets to your children: As in the case with Bill and Jill, you may be looking to pass assets to your children. For children who will likely be in higher tax brackets by the time they inherit assets, the Roth IRA account may be a more advantageous way to transfer wealth income tax free (not estate tax free). Remember, an IRA that is passed from you to your child/children, generally needs to be taken out within 10 years and would be taxed at their ordinary income tax rate. Depending on the size of the IRA, that can be a big tax bite for your kids and could eat into their inheritance. If these assets are converted to a Roth, the assets would still need to be taken out within 10 years but wouldn’t be taxed.

Tax Diversification: Just like we encourage diversification within our investment portfolios, tax diversification is just as important. Having some assets in taxable accounts, some in pre-tax accounts, and some in after-tax/tax-free accounts can act as a hedge against changing tax legislation. Whether it’s pre-retirement, or post-retirement, it’s never too late to shift some income to a Roth to diversity the tax treatment of your accounts.

A Few Final Notes of Caution

While using a Roth conversion strategy can certainly benefit many, there are a few items to consider before pulling the trigger:

  • First and foremost, make sure you loop in your CPA before implementation. There may be other tax implications that haven’t been considered (and this may impact when you need to make estimated tax payments).
  • While not required, this strategy generally works better if you have assets outside of your IRA to pay the taxes. It also works better if you don’t need the Roth IRA to satisfy cash needs. It gives the account(s) longer to grow tax free.
  • Unlike in prior years, you can’t recharacterize (or undo) a Roth conversion once it’s done so make sure you’re sure before you pull the trigger. It might be helpful to complete these closer to the end of the calendar year if you aren’t clear on income for the year.
  • It isn’t all or nothing. Just like in the case of Bill and Jill, you can convert smaller chunks of your IRA(s) into a Roth each year to better manage taxes.
  • If you are considering converting more but don’t want to exceed a certain amount for tax purposes, you may think through various ways to accelerate income at the same time to help offset the income (as an example, in a year when you do a $50,000 Roth conversion, doing a donation to charity from your taxable account to help offset some of the tax burden).
  • Be mindful of how an increase in income may impact your Medicare premium.

This is the type of proactive analysis we are providing for clients all the time, so please reach out if we can help you think whether something like this makes sense for your and your family’s unique situation.



Tax Brackets 2022

2022 RMD Table

Life Expectancy Table

IRA Minimum Distribution Table