Roth conversions

Every rule has a traditional source and a Roth destination for the same owner. There are three ways to create one:

• A fixed annual cap. Tax tools›Conversion scenarios under Manual Roth conversions: choose the Traditional source and Roth destination and enter the Annual conversion cap. The rule runs every year until the source is empty.
• Fill a bracket. Tax tools›Strategy comparisons: compare bracket targets, then Apply one. The applied rule keeps the Convert from and Convert until milestones and the MAGI cap you chose (see Compare strategies before applying one).
• From the allocation list. Income allocation›Payroll contributions and account transfers, with the priority type Roth conversion. Its Annual maximum works like the cap above.

Conversion rules run in list order. When several are active in one year, a later rule gets only the bracket and income room the earlier ones left. On iPhone, a Roth conversion rule under Income allocation can also be set to fill a bracket, with an income cap, directly.

A fixed rule converts its cap, or the whole remaining balance if that’s smaller. A fill-to-bracket rule converts the room left below the top of the chosen bracket:

Taxable ordinary income is the year’s income after deductions, not counting long-term gains and qualified dividends. Bracket tops are the federal brackets for your filing status, indexed as described in Federal brackets, deductions and indexing. Plans using flat tax rates have no brackets to fill, so these rules convert nothing.

An income cap then limits either kind of rule: the cap, raised each year by the plan’s inflation rate because you enter it in today’s dollars, less the year’s modified adjusted gross income before the conversion.

A conversion or gain harvest rule can take its room from the plan’s tax target instead of its own bracket and income cap. Check Use plan tax target on the rule. The rule then converts, or harvests, as much as keeps the year’s final income within the target and every ceiling you checked with it: the net investment income tax threshold, the first Medicare IRMAA tier (using the ranges projected for the premium year two years later) or a share of the poverty line in Marketplace coverage years. Its annual maximum still applies.

With a 12% bracket target and no gains or dividends, a rule using the plan target converts exactly what a fill-to-12% rule converts. Bracket targets count capital gains and qualified dividends in taxable income, so in a year with gains it converts less, leaving the gains within the bracket.

Rules using the target share one room with each other and with withdrawals that fill the target (see How shortfalls are funded). Gain harvests use it first, then the first withdrawal pass, then conversions in list order.

The whole amount converted is taxable. The conversion itself is never charged the early-withdrawal penalty, at any age. Its tax is part of the year’s federal and state tax, settled like any other tax (see Withholding, refunds and balances due): from the year’s income first, then by your withdrawal order. If that order reaches a traditional account, the extra withdrawal is taxed too.

In the example above the tax came from a brokerage account. The sale realized a small gain, which the higher income moved from the 0% to the 15% capital-gains rate, so total tax rose by $15,541, not only the $15,346 of federal tax on the conversion.

Conversion income counts in adjusted gross income, so it can also raise the taxable share of Social Security, the Medicare premiums charged two years later, and Marketplace premiums through a smaller credit. See Medicare premiums and IRMAA and Marketplace coverage and premium tax credits.

Each year’s conversions start their own five-year clock on January 1 of that year. Withdrawing converted money before its clock runs out, and before 59½, costs the 10% additional tax on the part that was taxable when converted. The money itself isn’t taxed again.

Roth IRA withdrawals come out in a fixed order across all of the owner’s Roth IRAs: regular contributions first, then conversions oldest year first, then earnings. So converted money is reached only after contributions are used up. Roth 401(k) withdrawals follow a different, proportional rule; both are covered in Early withdrawal penalties and Roth ordering.

Strategy comparisons tests fill-to-bracket rules against your plan without changing it. You choose the Pre-tax source, the Roth destination, when to convert (Convert from, default Start of plan; Convert until, default Funds are exhausted), an optional MAGI cap in today’s dollars, the objective, and the bracket ceilings to test from 10% to 32%.

CoastMath runs the full projection once with no new conversions and once for each ceiling. For each it reports the objective and its difference from the baseline, the total converted and over how many years, lifetime taxes, health coverage costs, net estate, the years with a Medicare surcharge, and the years that lost a premium tax credit. The best result is only the best of the ceilings you tested, and a strategy that makes the plan run short is marked. Nothing changes until you Apply one.

Open Advanced search under Tax tools›Strategy comparisons to try more than bracket ceilings. You choose which bracket rates to test as the plan tax target, which actions to pair with them (Roth conversions, capital gain harvesting, blending withdrawals up to the target), any of three alternative withdrawal orders (cash and taxable accounts first, pre-tax accounts first, Roth before pre-tax), up to four timing windows, and one objective. Each side of a window is a milestone, a calendar year or your age, and a year or age end is included: a window from 2030 through 2035 stops at the start of 2036. Besides the objectives in the comparison, you can rank by lifetime effective tax rate, total Marketplace premium credits, total required distributions or total Medicare surcharges. Each objective says whether higher or lower is better.

The search runs in stages and every candidate is a full projection of your plan. It first tries each bracket rate you picked with all your chosen actions on, which ranks the rates. Combinations with the other choices follow: simpler ones at the best rate and its neighbours, then simpler ones at the other rates, then the rest. Identical candidates are simulated once. The simulation budget, from 2 to 128, is a hard limit: when the combinations outnumber it, the search says how many it skipped and the rest are left unsimulated.

Results are ranked by the objective, with a plan that runs short ranked last. The best result is only the best of the combinations that were simulated: a different rate, order or window you didn’t include could do better, so treat it as a lead, not an optimum. A withdrawal order preset regroups your saved order by account type and keeps your saved order within each group.