Most advisors understand the importance of talking with clients about the benefits of executing Roth conversions as part of an effective retirement income planning strategy during their working years. Discussing the pros and cons of the Roth conversion strategy once the client has actually entered retirement is much less common.
For the right client, though, a series of Roth conversions can add significant value, in terms of improving income options and tax situations during retirement and furthering estate planning goals. The need to identify tax-savvy financial planning strategies doesn't disappear once clients stop working, and in-retirement Roth conversions may be a smart move.
Cash and Tax Bracket Control
Retirement can be an ideal time to execute Roth conversions because clients may be in a lower tax bracket when compared with their prime working years.
As an initial matter, it's important to remember that when traditional IRA funds are converted to Roth funds, the entire amount converted is taxed as ordinary income. If the client doesn't have sufficient cash on hand to cover the tax liability, the Roth conversion is rarely advisable. Clients with enough cash on hand to cover expenses (in addition to tax liability) during the year of conversion also have the best odds of being in the lowest tax brackets — reducing the overall tax cost of the conversion.
The client's age is also important. If clients have retired but are not yet subject to required minimum distribution rules on traditional retirement accounts, they have more control over their income levels for the year of conversion. The same applies to clients who aren't yet claiming Social Security benefits.
The Roth conversion itself can also serve to reduce the value of taxable RMDs once the client does become subject to those distribution rules.
