5 Reasons You Should Review Your Roth Conversion Strategy Each Year

Roth conversions can be a powerful way to manage your tax liability over the course of your lifetime. However, you should have a deliberate and systematic Roth conversion strategy that is aligned to your priorities and your specific situation.  

However, it’s not enough to just have a Roth conversion strategy that never changes. You should review your Roth conversion strategy each year so that you can make adjustments. Here are 5 reasons why. 

REASON #1: CHANGES IN THE TAX LAW MAY IMPACT YOUR STRATEGY 

It seems that the tax law is always changing. In the period from 2017 to 2020, there were 3 laws passed with significant impacts (both permanent and temporary) to the tax code: 

• The Tax Cuts & Jobs Act of 2017 
• The SECURE Act of 2019 (SECURE stands for Setting Every Community Up for Retirement Enhancement) 
• The CARES Act of 2020 (Coronavirus Aid, Relief, and Economic Security) 

Each of these law changes provided challenges and opportunities for Roth conversions. For example, the CARES Act suspended required minimum distributions (RMDs) on IRAs and qualified retirement plans for 2020. This allowed people who would otherwise have been forced to take a distribution to make a choice: 

• Use that same distribution as a Roth conversion instead 
• Simply keep the money in the IRA and pay a lower tax bill in 2020 

Of course, making that choice implies that you’re reviewing your plan each year and weighing the options. 

REASON #2: YOUR TAXES MIGHT CHANGE 

Many people think that once you retire, your finances get simpler. And sometimes they do. However, your taxes might change, even if your finances are as simple as possible, simply because of changes that were not expected or not in your control. And when your taxes change, you’ll want to look at your Roth conversion strategy to see if you need to make adjustments. 

Here are several things you should be looking out for each year: 

• Increase in taxable income: Your taxable income could go up, or it could go down. Even in retirement, many people actually experience an increase in taxable income. Most of the time, it’s because of RMDs. But it could also be because of: Pensions 
• Annuities 
• Capital gains on sales of investments (or investment property) 
• Deferred compensation 
• Social Security 
• Retirement plan distribution (other than RMDs) 
• If this happens, you’ll probably want to look at your Roth conversion plan to make sure you remain in a desirable tax bracket. 

• Decrease in taxable income: Of course, the opposite might happen. Your deferred compensation might completely pay out, or you might not have capital gains in a given year. Or for some other reason, you might simply have figured out a way to lower your tax bill for the year.   

In this case, you’ll want to see if it’s sustainable. In some instances (like avoiding capital gains), it might be completely sustainable. In others (like the CARES Act eliminating RMDs for only the tax year 2020), you might have to review your tax situation and make adjustments. 

• Change in tax filing status: In retirement, probably the most common change in tax status is when someone loses a spouse. However, many people also get married or divorced after retirement. All of these are legitimate reasons to take a look at your taxes for challenges (or opportunities). 

And even if your tax status doesn’t change, your tax bill almost always does. If you do mid-year tax reviews with your tax or financial advisor, it’s a perfect time to see how much you should be paying in taxes as you do your Roth conversions, as well as how much you might owe or expect as a refund at tax time. And to make sure your Roth conversion strategy is intact. 

REASON #3: LIFE CHANGES MIGHT OCCUR 

As mentioned above, significant life changes could happen that might directly impact your taxes, like a change in tax filing status. But more importantly, there might be changes in your life, which indirectly impact your taxes.  

Perhaps there are changes that require more money than you originally thought. And you’re pulling more from your IRA (or selling investments in your non-qualified account).  

Maybe you’ve started taking Social Security and you need to account for that in your Roth conversion strategy.  

The bottom line is that as changes in your life happen, you should be looking to see if you need to make adjustments to your Roth conversion strategy. 

REASON #4: YOU MIGHT WANT TO REVIEW THE STOCK MARKET’S IMPACT ON YOUR PORTFOLIO 

If you manage your own investments, you might see this as an opportunity to evaluate the investments inside your portfolio. While your investments might not have a direct impact on your Roth conversion strategy itself, there might be some things worth looking at: 

• Are your investments in the right location (tax-wise)? For tax-efficiency, you may consider how each type of account is invested, based on the tax treatment. For example, your highest-earning investments might do better in a Roth account, because you’ve already paid taxes and you want your investment growth to be tax free. Conversely, if you have bonds or CDs as part of your portfolio, you might want them to be in your pre-tax retirement account because they won’t earn as much as your other investments, but the interest income is taxed at ordinary income rates (unless you’re investing in municipal bonds). 
• Do you need to rebalance? Without turning this into an article about investment advice, evaluating your Roth conversion strategy (and the accounts involved) always gives you the chance to see if rebalancing is in order. 
• Is there an impact on the timing of your Roth conversion? For example, let’s imagine that you had planned to do a Roth conversion later in the year. However, the stock market has been in a slump recently (one that you’re confident we’ll get out of). It might be worth considering moving your Roth conversion up to take advantage of the down stock market. That way, you convert more shares of your securities at the lower price point. Then, as the stock market recovers, those holdings increase in value tax-free.  

 Of course, the opposite might be true—you might convert fewer shares at a higher price point if the stock market is on a tear. However, don’t let the tail wag the dog here—as long as you stay with the planned dollar amount, it’s probably better to make the conversion anyway instead of pushing the Roth conversion off to later in the year (or next year). 

And if you don’t do your investments, these are all fair questions to talk about with your financial advisor during your tax planning meeting.  

REASON #5: YOUR PRIORITIES MIGHT CHANGE 

It’s good to revisit your Roth conversion strategy just to make sure that your assumptions are still intact. While Roth conversions might have been important when you first started, perhaps your perspective has changed. Here are a couple of examples: 

• Charitable contributions are more important. Perhaps you’ve decided that you want to contribute more to charity. If that’s the case, then it doesn’t make sense to pay any taxes for Roth conversions on money that might make its way to charity. Certainly, this is something that people struggle with when trying to balance charitable contributions and Roth conversions.   
• It might be more tax-efficient for your beneficiaries might be able to pay the taxes on IRA distributions. You might have wanted to pay taxes on Roth conversions so that your beneficiaries didn’t have to, even if it didn’t make the most tax sense to you. But you might have changed your mind. 
• Your tax bracket might not look that bad when you start having to take RMDs. Perhaps you’re not on track to convert everything into a Roth, but you might have converted enough. And if you’re able to keep your current taxes low while avoiding tax creep when you start taking RMDs, maybe you don’t need to do much more. 

CONCLUSION 

While it’s important to have a Roth conversion strategy, it’s even more important to have a system in place to periodically review it. After all, when life happens and changes occur, those changes might warrant adjustments to your carefully well-thought out strategy. And if you review your strategy each year when you do your tax planning, you’ll be in a great position to make those adjustments. Ready to schedule your first introductory call? Schedule your 30 minute call here.