Vanguard Says This Tax Move Benefits More Than 80% of Retirees

Vanguard reports that more than 80% of investors could meaningfully improve their modeled retirement outcomes by including Roth conversions in a broader income plan. That doesn't necessarily mean that four out of five retirees are guaranteed to save money since every person has a different tax situation, life expectancy, and future withdrawal amounts. 

Still, the result points to a tax move that deserves a place in many retirement plans. The most valuable opportunity may appear during a brief window when income temporarily falls — after you call it quits at work and before required minimum distributions, or RMDs, begin.

A Roth conversion moves pretax money from a traditional IRA or eligible workplace retirement plan into a Roth IRA. The converted amount generally becomes taxable income for that year, but qualified Roth withdrawals can be tax-free later. In simple terms, you pay tax at today's rate to avoid potential taxes on the same money and its future growth later.

The real challenge is deciding how much to convert, and when.

The gap years can create a lower tax window

Taxable income often drops after a paycheck ends but before Social Security benefits and required minimum distributions, or RMDs, begin. Under current law, RMDs generally start at 73 for people born from 1951 through 1959 and at 75 for those born in 1960 or later.

Those gap years may allow a retiree to convert part of a traditional IRA while remaining in a lower federal bracket than they were in during their working years. It isn't automatically the right move, but the timing can potentially make the tax bill easier to manage.

Smaller future RMDs may protect tax flexibility

Pretax balances may keep growing until RMD rules force money out, whether or not the retiree needs it for everyday spending. Large distributions may push income into a higher tax bracket, make more Social Security benefits taxable, or increase income-related Medicare premiums.

Converting part of the account earlier reduces the balance used to calculate future RMDs, while original Roth IRA owners don't have lifetime RMDs under current IRS rules. That gives retirees more control over which account supplies income in a particular year.

A surviving spouse may face higher tax rates

Married couples generally receive wider federal tax brackets and a larger standard deduction than single filers. After one spouse dies, the survivor may eventually file as single while managing many of the same household expenses, investments, and retirement accounts.

That shift could potentially place the surviving spouse in a higher marginal bracket even if total household income falls. Building Roth assets while both spouses are alive may give the survivor a source of qualified tax-free withdrawals after the filing status changes.

Roth money can be easier on many heirs

Inherited Roth IRAs can provide beneficiaries with tax-free qualified withdrawals, although most nonspouse heirs generally must empty an inherited account within 10 years. Withdrawals from an inherited traditional IRA, by comparison, are usually taxable to the beneficiary.

A conversion can therefore shift the tax bill from an heir to the original account owner, which may help when the owner expects to pay a lower rate than the next generation. Estate goals shouldn't drive the decision alone, but they can strengthen the case for a measured conversion.

Large conversions can create expensive side effects

On the flipside, converting too much in one year may push part of the amount into a higher tax bracket and increase Medicare's income-related monthly adjustment amount, or IRMAA. Medicare generally uses tax-return information from two years earlier to determine your monthly premium for that year, so a conversion at 63 could affect premiums at 65, while a later conversion could raise costs for someone already enrolled.

A more cautious approach is to pace conversions over several years and, when possible, pay the tax from a taxable account rather than withholding it from retirement money. Keeping the converted assets intact gives more of the balance a chance to grow inside the Roth IRA.

Bottom line

Would paying a known tax bill during a lower-income year give you more control than waiting for RMDs, Social Security, and other retirement income to arrive together? The answer depends on your current bracket, expected future tax rate, IRA balance, Medicare exposure, available cash, and goals for a spouse or heirs.

It's a smart idea to run several conversion amounts before acting rather than treating the decision as all or nothing. A qualified tax professional or fiduciary advisor can help compare the immediate cost with the potential lifetime benefit, and careful planning may help you keep more cash in your wallet throughout retirement.

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