Definition
A Roth conversion transfers assets from a pre-tax retirement account (Traditional IRA, 401k) to a post-tax Roth account. The converted amount is taxed as ordinary income in the conversion year; subsequent growth and qualified withdrawals are tax-free.
Trade-off Function: Pay tax at known current rate τ₀ vs. unknown future rate τ₁. Conversion is tax-efficient when E[τ₁] > τ₀, or when reducing future RMD tax burden.
The deeper insight: Roth conversions are really about tax bracket arbitrage. You're buying Roth space at today's marginal rate. If you can convert at 12% and would have withdrawn at 22%, you've captured a permanent 10% spread on every dollar — including all future growth.
Bracket Fill Algorithm
Optimal conversion amount fills available space in target tax bracket without triggering higher marginal rates:
Calculation Example
Married couple, age 60, with pension income:
Tax on conversion: $63,500 × 12% = $7,620
Constraints and Edge Cases
IRMAA Threshold: High AGI in conversion year can trigger Medicare Part B/D surcharges 2 years later. 2024 threshold: $206k (MFJ).
- 5-year rule: Each conversion has separate 5-year clock for penalty-free principal withdrawal (if <59½)
- Irreversibility: Post-2017 TCJA, conversions cannot be recharacterized
- Pro-rata rule: Non-deductible IRA basis complicates conversion tax calculation
- State taxes: Some states don't recognize Roth tax treatment
- ACA subsidies: Conversion income affects premium tax credit eligibility
RMD Reduction: Converting pre-tax assets reduces future Required Minimum Distribution amounts, potentially avoiding higher marginal rates at age 73+.
The Early Retiree Window: Those who retire before Social Security begins (typically 55-67) have a unique opportunity. With no W-2 income and no SS, taxable income can be near zero. This creates a window where you can convert at 10-12% rates that may never return. The window closes when SS and RMDs begin.