Oftentimes, as clients retire, a window of opportunity opens. If they retire before beginning RMDs, or in some cases even prior to starting Social Security, they may find themselves in the lowest tax bracket they’ve been in since they became employed. This can be a great time to complete Roth conversions, which are the movement of pretax money into a post-tax Roth IRA. The obvious cost at the time is the taxes due on the converted amount, as the money is treated as ordinary income. However, several oft-forgotten costs to Roth conversions may make them less beneficial than previously estimated. Naturally, these are client-dependent and may not affect every individual, nor are they reasons to forgo the conversion, but they are worth investigating when determining if the conversion makes sense.

• Social Security Taxation: For those looking at making conversions while receiving Social Security benefits, remember the rules regarding taxation. Given one’s income and filing status, anywhere between 0 and 85% of their Social Security can be taxable. Because the Roth conversion counts as income, processing one could result in a higher portion of the client’s Social Security being taxable.
• Medicare Income Related Monthly Adjustment Amount (IRMAA): Medicare Part B and Part D premiums are based on your MAGI (modified adjusted gross income) reported two years prior. There are six premium brackets calculated based on filing status and income. A Roth conversion could cause a client to be subject to higher premiums two years from the year in which a Roth conversion is processed.
• Net Investment Income Tax (NIIT): NIIT is an additional 3.8% tax applied to the net investment income of individuals (estates and trusts). As with the aforementioned topics, the income thresholds vary based on filing status and are calculated using MAGI. A Roth conversion may cause interest, dividends, capital gains, and rent and royalty income (among other items) to be subject to NIIT.
• Capital Gains Impact: The tax rate on capital gains is determined by taxable income and the client’s filing status. This impact can be especially hurtful given that a couple who files jointly can pay 0% on capital gains up to $96,700 of taxable income in 2025. If the income from a Roth conversion raises taxable income above that threshold, it will push some or all of the capital gains (depending on the amount) from 0 to 15%! Combine this with potential NIIT, and you could be looking at an 18.8% tax increase.
• Five-Year Rule: Many of you may be familiar with the 5-year rule for Roth contributions, which is relevant when determining whether the growth/appreciation in the Roth IRA is tax-free when withdrawn. But there is also a 5-year rule for Roth conversions. This rule determines whether the converted principal amount will be subject to the early withdrawal penalty. It’s important to note that in the event of multiple conversions over several years, each conversion has its own 5-year period that it needs to satisfy. It’s also important to note that this rule only applies to taxpayers who have not reached age 59 ½. If the taxpayer is 59 ½ or older, the early withdrawal penalty does not apply, regardless of how much time has passed since the conversion.

The value of a Roth conversion is not as simple as comparing current tax rates to projected future tax rates. Several other “hidden costs” should be evaluated before making a decision. After all, as of 2018, Roth conversions can no longer be recharacterized. There are no do-overs, so take a deep dive before forging ahead with this popular strategy.

Ryan Naples is a financial planner for The Hucko Group.

Editor: Greg Filbeck, CFA, FRM, CAIA, CIPM, PRM, Samuel P. Black III, Professor of Finance & Risk Management, Penn State Erie, mgf11@psu.edu