Why a Roth Conversion Is Wrong for Most People But Often Right for Pension Holders

Roth conversions have become one of the hottest topics in retirement planning. Browse financial headlines long enough, and you'll likely encounter conflicting advice.

Some experts argue that everyone should convert their traditional IRA to a Roth. Others insist it's a costly mistake. The truth is far more nuanced.

As a CERTIFIED FINANCIAL PLANNER® and CEO of Peak Retirement Planning, I can tell you that for most Americans, a Roth conversion probably isn't necessary. However, retirees with pensions often live by a different set of tax rules (I wrote a book for those with pensions, The 2% Club, that you can request for free here.)

Their guaranteed income can create tax challenges that don't apply to the average retiree, making Roth conversions worth a much closer look.

Before deciding whether a Roth conversion belongs in your retirement strategy, it's important to understand the factors that actually determine whether the math makes sense. You can learn more about this in my YouTube video:

The only question that really matters

Many investors focus on whether they can afford to pay the taxes on a Roth conversion today. While that's certainly part of the equation, it isn't the deciding factor. The more important question is this: Will your total tax rate be lower today than it will be later?

That "total tax rate" extends beyond your federal income tax bracket. A Roth conversion can also influence:

• State income taxes
• Medicare IRMAA surcharges
• Social Security taxation
• Capital gains taxes
• Estate planning outcomes

When viewed together, your true tax cost could look very different than your federal bracket alone suggests.

Why most people don't need a Roth conversion

For many retirees, taxable income will naturally decline when they stop working. Someone who retires with modest retirement savings, no pension and Social Security as their primary income source usually remains in relatively low tax brackets throughout retirement.

In those situations, paying taxes today through a Roth conversion could result in paying more tax than necessary.

Roth conversions are frequently overpromoted, as they can be powerful, but they aren't universally beneficial.

Pension holders face a different tax reality

Rather than seeing their income in retirement decline, retirees with pensions often have multiple sources of guaranteed retirement income arriving simultaneously:

• Pension payments
• Social Security benefits
• Required minimum distributions (RMDs) from traditional retirement accounts

Each source adds taxable income, and together they can keep retirees in higher tax brackets for decades.

For households that have accumulated substantial balances in tax-deferred accounts, such as 401(k)s, IRAs, TSPs or 403(b)s, RMDs can make the situation even more challenging as they grow over time.

That's why many pension recipients find themselves paying as much, if not more, in taxes during retirement than they did while working.

Today's tax environment creates planning opportunities

Another consideration is today's tax landscape: Current tax laws provide relatively favorable tax rates and expanded standard deductions compared with historical norms.

While no one can predict future legislation, many economists expect government revenue needs to increase over time because of rising national debt and the long-term funding challenges facing programs such as Medicare and Social Security.

If future tax rates eventually rise, converting portions of traditional retirement accounts while rates remain relatively low could produce meaningful lifetime tax savings. The objective isn't simply to pay taxes sooner, but to pay them when they're expected to be lower than they otherwise would be.

Don't look only at your tax bracket

One of the biggest mistakes retirees make is evaluating Roth conversions using only the federal tax tables. Your retirement tax picture is much more interconnected.

Increasing taxable income through a Roth conversion could:

• Cause more of your Social Security benefits to become taxable
• Push you into a higher Medicare IRMAA bracket, increasing Medicare Part B and Part D premiums
• Raise your capital gains tax rate
• Increase state income taxes

This is why comprehensive tax planning frequently produces better results than simply converting up to the top of a particular tax bracket.

The widow's penalty can create future tax problems

Married couples regularly overlook one significant future risk: When one spouse dies, the surviving spouse generally transitions from married filing jointly to single tax status. At that time:

• Tax brackets and IRMAA thresholds shrink
• The standard deduction lowers
• One Social Security benefit typically disappears
• The surviving spouse often continues receiving pension income and RMDs

The result can be substantially higher taxes for the surviving spouse. Completing Roth conversions while both spouses are alive allows couples to take advantage of the wider married tax brackets before this transition occurs.

Your children's tax situations matter, too

If leaving money to your children is one of your goals, their future tax bracket deserves consideration as well.

Under current law, most non-spouse beneficiaries must empty inherited retirement accounts within 10 years. A child inheriting a large traditional IRA might be required to recognize hundreds of thousands of dollars of taxable income during that period, potentially pushing them into significantly higher tax brackets.

On the other hand, if your children are likely to remain in relatively low tax brackets, leaving them traditional retirement assets instead of paying higher taxes through Roth conversions today could prove more efficient.

Estate planning isn't one-size-fits-all, and understanding your heirs' financial circumstances is an important part of the analysis.

Tax diversification provides flexibility

Many retirees have accumulated the vast majority of their wealth inside tax-deferred retirement accounts, and that creates a challenge. Every dollar withdrawn becomes taxable income, leaving retirees with limited flexibility when tax laws or personal circumstances change.

Building assets across multiple account types — including traditional retirement accounts, Roth accounts and taxable brokerage accounts — creates what many planners call tax diversification.

Having multiple "tax buckets" allows retirees to decide where retirement income comes from each year, making it easier to adapt to changing tax laws, Medicare thresholds or unexpected expenses.

Where you live can affect the timing

State taxes can also influence whether a Roth conversion makes sense. Someone planning to relocate from a high-income-tax state to one with no state income tax could benefit from delaying Roth conversions until after the move.

Conversely, someone expecting to move into a higher-tax state might decide to accelerate conversions before relocating.

State taxes generally receive less attention in planning than federal taxes, but they can meaningfully affect lifetime tax costs.

A common Roth conversion myth

One objection frequently raised against Roth conversions is that paying taxes today means losing years of investment growth. That argument overlooks an important concept: Taxes on a traditional IRA already represent a future liability.

Paying that liability earlier doesn't necessarily reduce long-term wealth if tax rates remain unchanged — it simply satisfies the government's share sooner.

Where Roth conversions can create additional value is by reducing future RMDs, potentially lowering Medicare premiums, limiting Social Security taxation, providing greater withdrawal flexibility and protecting against higher future tax rates.

The comparison isn't simply about investment growth — it's about maximizing what you keep after taxes over the course of retirement.

The bottom line

Roth conversions aren't appropriate for everyone. In fact, many retirees with modest savings and no pensions might be better off leaving their traditional retirement accounts untouched.

Pension holders, however, ordinarily face a different reality. Guaranteed income, RMDs and long retirement horizons can create tax burdens that make proactive planning far more valuable.

Rather than asking whether Roth conversions are "good" or "bad," ask a better question: Will paying taxes today likely cost less than paying them later?

For retirees with pensions and substantial retirement savings, the answer is often worth exploring through a comprehensive, long-term tax strategy that considers not only income taxes but also Medicare premiums, Social Security taxation, estate planning and future tax flexibility.

Because when it comes to retirement, it's not just about how much you've saved — it's about how much you'll ultimately keep.

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