By Rusty Russell, CFP®, CKA®, CWS®, CEPA®
People tend to assume the tax decisions that matter happen sometime around filing season. I understand why. That's when you finally see the number. But by the time you're looking at that return, the choices that produced it were made months before, often without much thought at all. April doesn't decide anything. It just tells you what has already been decided.
I think the more useful way to look at it is that filing season is paperwork, and the real planning window closes a lot earlier, on December 31st. That's the deadline that actually shapes what you owe, and it's the one I want to talk about this fall, because there's a tool tied to it that a lot of business owners and pre-retirees either don't know about or assume doesn't apply to them: the Roth conversion.
What a Roth Conversion Actually Is
A Roth conversion is when you take money out of a traditional IRA or 401(k), pay the tax on it now, and move it into a Roth account, where it can build value over time and eventually comes out tax-free. People sometimes confuse this with a Roth IRA contribution, which has a strict annual limit, but a conversion isn't capped in the same way. You can convert as much as you want in a given year. The real question is how much to convert and what tax rate you're willing to pay on the conversion. More isn't automatically better.
There’s also a five-year rule to consider. The specifics depend on your circumstances, but the important point here is that when you convert can matter just as much as how much you convert.
Why Timing Matters More Than the Amount
A good Roth conversion strategy isn't just about how much you convert. It's also about when you convert it. The best windows tend to be years when your income dips below its normal level, an early stretch of retirement before Social Security starts, a slower year in the business, or the gap between selling a practice and required withdrawals kicking in. Converting during one of those years usually means paying tax at a lower rate than you would later, once income climbs back up.
Two practice owners could save the same amount and still have very different outcomes. Both could retire with $1 million in retirement accounts. But if one has all $1 million in a traditional IRA and the other used lower-income years to strategically convert part of those savings to Roth, they don't really have the same $1 million. One still owes income tax on every dollar withdrawn from the traditional IRA. The other has already paid the tax on the money converted to Roth.
The account balances may look the same. The after-tax value isn't. And having money in both traditional and Roth accounts gives you more options for managing your income and taxes in retirement.
What Can Happen if You Wait
If you don't make a decision, nothing dramatic happens right away, and that's part of what makes it easy to put off. But the account keeps building value over time in the background, and eventually a decision gets made for you anyway. Required withdrawals begin at a certain age, whether or not you need that money that year. More of your Social Security can end up taxable than you'd expect. And a large withdrawal landing in one year, especially stacked on top of other income, can ripple into higher Medicare costs the following year too.
None of these outcomes are necessarily bad. The point is that planning ahead gives you more options and more control over the tax decisions you make.
Where This Leaves You
For anyone with some real control over the timing of their income, and that includes a lot of business owners, recent sellers, and people in the early years of retirement, the fourth quarter is an important planning window. Some of these decisions take time to work through, so don't wait until Christmas to start planning.
If you're wondering whether this is a year to look at a conversion, that's exactly the kind of question a year-end review is built for. If you’d like to talk it through, we’re happy to help you determine whether this is the right move for your circumstances before the year closes. Schedule your year‑end review here or give us a call.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.
A Roth IRA conversion—sometimes called a backdoor Roth strategy—is a way to contribute to a Roth IRA when income exceeds standard limits. The converted amount is treated as taxable income and may affect your tax bracket. Federal, state, and local taxes may apply. If you’re required to take a minimum distribution in the year of conversion, it must be completed before converting.
To qualify for tax-free withdrawals, you must generally be age 59½ and hold the converted funds in the Roth IRA for at least five years. Each conversion has its own five-year period, and early withdrawals may be subject to a 10% penalty unless an exception applies. Income limits still apply for future direct Roth IRA contributions.
This material is for informational purposes only and does not constitute tax, legal, or investment advice. Please consult a qualified tax professional regarding your individual circumstances.