How Much Can I Convert to a Roth IRA?
How much can I convert to a Roth IRA? This is an important question in Retirement planning. Especially now in 2021, when the very future of Roth accounts is under legislative attack.
The decision whether or not to perform a series of yearly partial Roth conversions is usually not a difficult one. How much to convert to Roth, however, takes earnest consideration. Especially now!
What is the optimal amount to convert to Roth in 2021?
Let’s start simple and remind ourselves why we might want to convert to a Roth in 2021.
You have brokerage accounts, pre-tax accounts (where you deferred paying taxes during your working years), and Roth accounts where you have already paid the taxes. Roth accounts are awesome for legacy, and to control your taxes in retirement!
The goal: tax diversification which means you have money in all three types of accounts.
- You can pull money from your brokerage account yearly and optimize your capital gains over your lifetime.
- Or, optimize your yearly tax bracket by withdrawing money from your pre-tax accounts.
- Finally, you can pull Roth money for lumpy spending goals with no tax implications.
In order to control future tax rates of both your ordinary income (which is usually pre-tax accounts in retirement), and your capital gains (which you can do through specific lot identification in your brokerage account), you need to have some tax diversification.
Now, in 2021, there is legislation to kill after-tax conversions, which means goodbye to the backdoor Roth and the Mega Backdoor Roth option. This will limit your ability to have Roth accounts! And, there is talk of limiting Roth conversions starting in 2032, depending on your income!
So, how much can I convert to Roth in 2021? If you are in your Tax Planning Window, it might be a good time to get some tax diversification and do Roth conversions before the end of the year.
How Much Can I Convert to a Roth in 2021
So, we now understand that you can minimize your taxes over your life by getting some tax diversification, and the future of Roth accounts is uncertain after 2021. So, how much can you convert to a Roth in 2021?
First, have a plan about who is going to pay the taxes on your pre-tax account. You? Your children? Charity? How aggressive you want to be depends on your goals and who is going to pay the taxes.
If you are going to leave money to your heirs, you might want to do more Roth conversions if they are successful and going to inherit money in high income tax brackets. If, on the other hand, you have a starving artist as an heir, they very well may have a lower tax bracket than you.
If you are going to leave money to charity, then you might not do any!
An Example of Roth Conversions
Let’s set up an extreme example. We have a solo 65-year-old who did well and has a large IRA. She either wants to leave it all to charity (and thus everything left over in the pre-tax account at 90-years old when she dies will be counted as tax-free), or she wants to leave it to an heir in the 50% combined tax bracket. How much can she convert, regardless of legislative risk?
Again, how much to convert depends on your goals, who is going to pay the taxes, and how much longer you have to live. Of course, the future of Roth conversions is unclear at this time, but let’s ignore that idea for a second.
You are almost never better off converting everything to a Roth, because you always want to have enough money to fill at least your standard deduction. Even if you have a little extra every year, a QCD can help mitigate taxes.
If you are leaving everything to charity, then controlling your personal lifetime tax rate is most important.
Whereas if you know your heir is going to pay taxes on 50% of the inheritance (say they are in the 39.6% tax bracket and state taxes are 13%– hello California!), you might want to convert it “all.” during your life. Again, leave enough behind to fill up your yearly standard deductions with the RMDs.
Let’s look at the “extremes” of conversion, up the the 22% bracket, and up to the 24% bracket. Of course, this is for someone with less than ~$2.5M in pre-tax accounts. Folks with more than that have different issues not addressed below.
Above, you can see how yearly income stacks up against future tax brackets if there is no changes to current tax laws. I want to start here, because this helps us understand how much we can Roth convert in 2021 given the legislative risk.
The 10% bracket is really small and you can’t really see it well. Above that, the 12% tax bracket becomes the 15% tax bracket in 2026 when the Tax Cut and Jobs Act Expires. This happens at age 71 above.
Next, the 22% tax bracket becomes the 25% tax bracket, and the size of that bracket increases in 2026. This is much better seen in the 24% tax bracket, which becomes the 28% tax bracket. Note how much larger this bracket is at age 71!
On the top, you can partial Roth Conversion planning for an Heir in the 0% tax bracket. In green, you can see the baseline with no Roth Conversions. Note that taxes increase at 70 when you are forced to take social security, and at 72, Required Minimum Distributions kick in. These RMDs increase over time and eventually force you above the 28% tax bracket. In blue, you do Roth conversions yearly to fill the 22% tax bracket. This keeps you out of higher tax brackets in the future. When all is said and done, your 0% tax bracket heir has $165k more in after-tax money by pursuing this strategy.
Next, look at the lower example. Here, green is still baseline. Now, however, your 50% tax bracket heir requires you to fill the 24% tax bracket yearly with Roth conversions. And, in 2026, you start to fill the 28% tax bracket. You can see that by doing this, you eventually run your pre-tax account out of money by the time you are 85. Here, we have “overconverted” to our detriment. Doing this, however, still means you will have $1.5M more in after-tax money for your heir.
Next, let’s consider how much we can convert to Roth in 2021.
So, How Much Should I convert in 2021?
Understand that we have no idea what future tax laws will be. But 2021 might be the last, best year to do Roth conversions.
Above, we can see the maximum amounts you might want to convert before 2025, and after 2026 when the Tax Cut and Jobs Act changes all the tax brackets. I wanted to review this because most people have less than ~$2.5M in their pre-tax retirement account and current versions of proposed legislation should not effect them. For you, 2021 is just a “normal” year to convert to Roth IRA.
However, currently, there is risk that the 35% bracket shrinks in size and the 37% bracket goes to 39.6%.
Also, if you are “high income” (think >450k with no inflation increase), you may not be able to do Roth conversions starting in 2032. And finally, since they are killing the backdoor and mega backdoor Roth, it seems as if the actual intent is to get rid of all Roth options for high income earners in the future.
So, if you think you will be “making” (or “spending” if in retirement) more than $450k a year in 10 years, and your plan calls for Roth conversions in the future, you might consider massive Roth conversions in 2021. These will cost you 37% plus state income taxes. If you are willing to pay the taxes now, this might work out well for you in the future. Likely you will find out how you did in 20-30 years.
If your conversion plan involves the 35% bracket or above in the future, it might be a great time to do Roth conversions in 2021. But note above, even aggressive conversion to the 24/28% tax bracket over time can reduce the size of the IRA.
What is your Roth conversion plan? Will you have that time, or will congress eventually prevent all Roth conversions regardless of income level?
Next, are you willing to pre-pay the taxes this year? Do you think you will be allowed to do any Roth conversions in the future?
The true shot across the bow, at least as I see it, is that income levels that restrict Roth conversions are not scheduled to increase with inflation. It seems the intention of congress is eventually to prevent high income earners from getting any money in Roth accounts. They want you, the high earner, to pay taxes now, and pay taxes later.
If your heirs are likely to be in a high tax bracket, consider large Roth conversions in 2021. This is especially true if you have a massive IRA.
If your heirs are likely be in a low tax bracket, or if you want to leave it all to charity, there is less urgency.
We truly don’t know the future, but if you are willing to pay the taxes now, you might be quite happy in 20-30 years that you did!