Converting a large sum like $865,000 to a Roth IRA is a strategic move for long-term tax benefits — including tax-free retirement income and eliminating required minimum distributions (RMDs) — but often comes with a hefty upfront tax bill. Transitioning from a traditional IRA or 401(k) to a Roth IRA means paying taxes on the converted funds. But with careful planning and strategic execution, it is possible to minimize the tax impact. Here’s how to do it.
Get matched with a financial advisor who can help you convert your pension funds.
Understand the basics of Roth IRA conversions
When you convert money from a traditional IRA or 401(k) to a Roth IRA, you are essentially converting pre-tax dollars to after-tax dollars. This conversion triggers a taxable event, meaning you will owe income tax on the amount converted. The key to minimizing taxes lies in understanding the timing and amount.
Strategy 1: Partial conversions over several years
Instead of moving the entire $865,000 in one year, consider spreading it over several years. This strategy helps prevent you from moving into a higher tax bracket. For example, if you are currently in the 24% tax bracket, converting a large amount could put you in the 32% or 35% tax bracket, significantly increasing your tax liability.
Example strategy:
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Year 1: Convert $200,000
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Year 2: Convert $200,000
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Year 3: Convert $200,000
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Year 4: Convert $200,000
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Year 5: Convert $65,000
By spreading the conversion, you keep your taxable income lower each year, potentially saving you thousands in taxes.
Keep in mind that any amount you convert will generally be subject to the five-year rule. This means that you cannot withdraw the converted amount without penalty for five years after you convert it.
A financial advisor can help you create a personalized conversion strategy to minimize your conversion taxes. Talk to an advisor today.
Strategy 2: Take advantage of lower-income years
If you anticipate a year of lower income (for example, retirement or a sabbatical), that may be the ideal time to make a conversion (although you may have to wait five years before you can use that income). During a lower income year, your total taxable income is lower, meaning the transfer amount is taxed at a lower rate.
Example scenario: If you retire at age 62 and plan to start taking Social Security at age 67, the years between 62 and 67 can be excellent for Roth conversions. Without work income and deferred social security, your taxable income is lower, allowing for a more tax-efficient transfer.
Strategy 3: Take advantage of tax deductions and credits
Take advantage of the available tax deductions and credits to offset the tax liability of your switch. Charitable contributions, medical expenses and business losses are examples of deductions that can reduce your taxable income.
Example tactics:
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Contributions for charity: If you itemize deductions, making large charitable contributions in the same year as your rollover can offset the increased taxable income.
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Medical expenses: If you have significant medical expenses that exceed 7.5% of your adjusted gross income, these can also be deducted, reducing your taxable income.
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Business Losses: If you own a business, operating losses can potentially be used to offset your taxable income from the rollover.
Strategy 4: Contribute to a Health Savings Account (HSA)
Contributing to an HSA can lower your taxable income. HSAs offer triple tax benefits: contributions are tax-deductible, growth is tax-free, and withdrawals for qualified medical expenses are tax-free. Maximize your HSA contributions to lower your overall taxable income.
Strategy 5: Convert during market downturns
When the market is low, the value of your traditional IRA or 401(k) investments may be lower. Converting during a recession means you roll over a smaller amount, resulting in a lower tax bill. Additionally, any subsequent growth occurs tax-free within the Roth IRA.
Consult with a financial advisor
Given the complexity of the tax laws and the significant amount of money involved, consultation with a financial advisor or tax professional is critical. They can help you tailor a strategy specifically to your financial situation and goals so you can maximize benefits and minimize tax burden. If you’re looking for a fiduciary financial advisor, this free tool can match you with up to three advisors.
It comes down to
Transferring $865,000 to a Roth IRA is a smart financial move for long-term tax benefits, but it requires careful planning to avoid a big tax bill. By spreading the conversion over several years, taking advantage of lower income years, taking tax deductions and credits, contributing to an HSA, and converting during market downturns, you can strategically minimize your tax liability. Consult a financial advisor to develop a personalized plan that meets your financial goals.
Retirement planning tools
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How much money do you need to retire? Find out using the SmartAsset pension calculator.
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Have an emergency fund on hand in case you encounter unexpected expenses. An emergency fund should be liquid – in an account that isn’t at risk of significant fluctuations like the stock market. The trade-off is that the value of liquid cash can be eroded by inflation. But with a high-interest account, you can earn compound interest. Compare savings accounts from these banks.
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