Monish Verma is its founding partner and CEO Vardhana Wealth ManagementA wealth advisory firm in Michigan.
Many investors view Roth conversions as a tax-saving strategy, paying taxes today to avoid larger tax liabilities later. However, for high-net-worth (HNW) families, they can serve a broader purpose.
A Roth IRA can create a tax-free pool of capital that can serve as a tax-free retirement income source or benefit future generations.
I’ve seen many investors with large, qualified accounts who let those assets grow until retirement, withdrawing the funds only when the required minimum distribution (RMD) period begins. But challenges can arise when this happens, including the RMD becoming so large that it pushes you into a higher tax bracket, because the IRS treats distributions from traditional IRAs and 401(k)s as ordinary income. Another challenge that can result is large tax liabilities being left for future generations, especially if heirs inherit such funds during their peak earning years.
To avoid those common mistakes, I often advise investors to consider a Roth conversion during what we refer to as the optimal retirement runway. Here’s what he looks like.
Finding the Optimal Window for Roth Conversions
Retirement runway is the period when you are not at peak earning potential but before RMDs begin. Perhaps you’re stepping back from full-time work and moving toward consulting or serving as a board member. This stage, while you are in a lower tax bracket, may be a good time to convert IRA assets to a Roth and benefit from a lower tax bill.
This window of opportunity typically occurs in the late 60s to early 70s, before RMDs start at 73. During this approximate 10-year window, I often advise clients to begin a disciplined cadence of converting a set amount to a Roth account each year, determined by the maximum amount that will keep them in their current tax bracket while adding income.
In addition to paying taxes on income at a lower rate today, your IRA account balance reduces, reducing future RMDs and the associated future tax liability. Plus, Roth assets grow and grow tax-free sooner.
However, Roth conversions are not the right option for everyone. They won’t work for you if you don’t have enough after-tax funds to cover the tax liability; Being in certain tax brackets also makes this option less attractive. Before moving forward with this strategy, you or an advisor should carefully evaluate your current tax situation.
Roth Conversion: More than a Retirement Strategy?
Traditional IRAs generally require beneficiaries to withdraw inherited assets within 10 years after the death of the original account owner. Those withdrawals are treated as ordinary income, potentially creating a larger tax burden for children who inherit these assets when they are already in a higher tax bracket.
In contrast, Roth distributions are generally tax-free. As a result, for some HNW individuals, a Roth conversion can serve as a multi-generational wealth builder and provide heirs with tax-free income rather than income that may be reduced by future taxes.
This strategy is particularly relevant for many HNW individuals whose retirement spending needs are already covered by their RMDs, Social Security, and other investment accounts. I encourage those clients to view their Roth account not as a retirement income source but as a multi-generational wealth bucket. By converting assets while remaining in a lower tax bracket, the family preserves more wealth for future generations
Because traditional IRA distributions increase taxable income, while Roth distributions do not, converting to a Roth can help control tax liabilities and keep investors within their tax bracket. Additionally, if one needs additional liquidity in retirement, the assets can be accessed without a tax bill, creating greater flexibility.
How it works for physicians, executives, and business owners
Roth conversions are often a suitable strategy for C-suite executives and physicians who have substantial capital in their retirement accounts and whose earned income declines significantly upon retirement.
Consider a doctor in his mid-60s who has a total salary of seven figures, which is more than he needs for his lifestyle. Now partially retired and serving on a few medical boards, he can spend 10 years converting $250,000 a year to a Roth IRA. This will result in lower RMDs in the future, tax-free growth of Roth assets, and a lower tax burden for their children.
In my experience, entrepreneurs and business owners are more likely to take advantage of a Roth conversion at or before monetization. One of my business owner clients converted $2 million from the sale of a business from an IRA to a Roth account. The existing liquidity paid taxes upfront, and the account can now grow into the millions tax-free. This capital will likely be passed on as a multi-generational asset, with the option to use it if needed or hold it as tax-free capital for future generations.
Not just for retirees
It’s also important to note that Roth conversions are not specific to IRAs. Under the new law, many employee-sponsored plans now offer in-plan Roth conversions within their 401(k) plans, allowing employees to convert a portion of their retirement savings from a pre-tax bucket to a Roth bucket within their 401(k) plan. While the converted amount will be recognized as taxable income, the assets can then be held tax-free in the Roth account.
This can be a valuable strategy for clients who want to build their tax-free wealth before retirement. Many of my C-suite clients who are still employed have begun to leverage this strategy as part of their long-term legacy planning.
Final Thoughts: A Flexible, Multipurpose Strategy
For many people, Roth conversions, when used thoughtfully and strategically, provide much more than tax savings. This is one of several approaches that HNW families can use to control overall tax liabilities, reduce future RMDs, increase retirement flexibility, pass tax-free wealth on to beneficiaries, and overall preserve more wealth for future generations. It’s important to talk to your financial advisor early on about how Roth accounts can fit into your retirement portfolio for the greatest benefit for you and your inheritance.
The information provided here is not investment, tax or financial advice. You should consult a licensed professional for advice regarding your specific situation.
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