Roth Conversion: A $100k Example
Roth Conversion: A $100k Example
“To convert, or not to convert; that is the question.” Not as philosophical or existential as Shakespeare’s original phrase, but perhaps if he was a modern-day wealth advisor, he would still ponder such a question. In any case, it’s a question many people do consider every year, and they wonder what long term impact it could have on their financial plan.
In any given year, whether to convert or not, and if so; how much, has an answer common to many financial planning questions, which is: it depends.
But to help conceptualize it, sometimes it helps to walk through a specific example.
Sara is the star in our example today. She is a single 40 year old woman, making $200,000 a year. She has an IRA with a balance of $250,000, and she converts $100,000 of that to a Roth IRA, as she loves the idea of tax-free income later on in life. After all, who knows where tax brackets will be by then.
So, she converts it. As you likely already know, every dollar converted from a Traditional IRA to a Roth IRA is taxed as ordinary income. In Sara’s case, the $100,000 will be taxed partially at 32%, and partially at 35%. For the sake of the example, let’s just call it 33.5%.
Sara chooses to pay the taxes for this conversion directly out of the IRA, because she doesn’t have $33,500 lying around to pay the IRS; so she withholds 33.5%, and converts the rest.
After the conversion, she now has the following:
Traditional IRA: $150,000
Roth IRA: $66,500 (what was converted from the IRA net of tax withholding)
So right off the bat, she is down $33,500. Even if she had chosen to not withhold taxes from the IRA, she would still be down $33,500 because she would have to withdraw that money from a savings or investment account to pay the taxes.
We’re assuming the IRA and Roth IRA are invested exactly the same, and let’s assume the average annual rate of return is 7.2%, roughly doubling the accounts every 10 years. We’re also assuming no further contributions or conversions are made.
Fast forward 25 years. Sara is 65 now, and her retirement accounts are as follows:
Traditional IRA: $900,000
Roth IRA: $400,000
If she hadn’t done the conversion and had to pay that $33,500 in taxes, her Traditional IRA account balance would be approximately $1,500,000, which is $200,000 more than the total of her Traditional and Roth IRA account. Since that $33,500 was sent to the IRS instead of staying invested and compounding over time, it makes a substantial difference over 25 years.
But now, Sara is retiring and wants to start withdrawing from the accounts. And here is where that Roth IRA can start to pay off.
Let’s assume she is going to withdraw 4% of the portfolio every year to supplement her income, and she’ll take it proportionally from each account:
Traditional IRA withdrawal: $36,000
Roth IRA withdrawal: $16,000
Since Sara is no longer working and her only income is these withdrawals and social security, her tax bracket is considerably lower now at 22%
So, the total withdrawal of $52,000 only results in $7,920 of ordinary income tax. If she was withdrawing $52,000 from her Traditional IRA only, it would be a tax liability of $11,440. A savings of $3,520.
If she does this over a 30-year retirement, that’s a tax savings of $105,600. Not bad, but not as much as she lost in gains from that initial $33,500 going to the IRS rather than staying invested.
Now, it’s important to pause here because… there is no way to know she will be in a 22% tax bracket 25 years from now. The 22% is based off today’s tax brackets, as of 2026. Where will they be in the year 2051? Does anyone know? I certainly don’t. However, the consensus is that tax rates will likely be higher in the future than they are now.
Why? Because right now they are historically low (see my article on this for more detail: https://www.everest-wealthadvisors.com/blog/taxes-glance-will-they-be-higher-or-lower-10-years). Also, with the ballooning national debt, it’s just logical that, for better or worse, the US government will need higher revenue, and higher taxes is the primary way of achieving that.
So, going back to our example, let’s say that, despite her lower income in retirement, her tax bracket is at 35%, because congress has risen tax rates across the board. Let’s revisit her distributions:
The $52,000 coming proportionally from her Traditional and Roth IRA will result in a tax liability of $12,600. Her tax liability of taking the $52,000 only from her Traditional IRA would be $18,200. Her tax savings each year due to the conversion is $5,600. Over a 30-year retirement, that’s a total savings of $168,000. Much closer (but still shy), of the $200,000 lost in market gains.
This illustrates the rule of thumb when it comes to Roth conversions: If you’re in a tax bracket now that is either higher or the same as you expect it to be in retirement, a conversion probably won’t make sense. What about if you’re in a lower tax bracket now than you expect to be in retirement? Well, let’s do our example over again, except this time Sara’s tax rate in the year of conversion is only 12%.
Sara is taking a year off work and decides to convert $100,000 from her IRA to her Roth IRA. So, her only income for the entire year is the conversion itself, putting her in the 12% tax bracket, which she again withholds from the IRA. In this case, $88,000 converts to the Roth instead of only $66,500.
In the year of her conversion, her balances are as such:
Traditional IRA: $150,000 ($250,000 initially minus the $100,000)
Roth IRA: $88,000 ($100,000 converted from the IRA less $12,000 withheld for taxes)
Fast forward 25 years. Sara is 65 now, and her retirement accounts are as follows (still assuming same rate of return and no further contributions or conversions):
Traditional IRA: $900,000
Roth IRA: $529,000
A total of $1,429,000, which is only $71,000 shy of where her total balance would have been if she hasn’t done the conversion and had to pay $12k in taxes. Because she was in a lower tax bracket in the year of the conversion, she could convert more to the Roth IRA and withhold less in taxes, so she winds up with significantly more than the first scenario.
Now let’s look at the distribution phase. She is 65 now, and starts withdrawing 4% of her portfolio, proportionally from both accounts: $36,000 from the IRA, and $21,000 (approx.) from the Roth IRA.
Let’s also assume that her tax bracket is 35% now, considerably higher than it was when she did the conversion.
Her $57,000 withdrawal from both retirement accounts causes a tax liability of $12,600. If she hadn’t done the conversion and was taking that $57,000 from her Traditional IRA, her tax liability would be $19,950. She is saving $7,350 a year, which is $220,500 over a 30-year retirement.
So, to recap; the taxes she had to pay on the conversion cost her $71,000 in lost compounding growth over a 25-year period, but she ended up savings $220,500 in taxes on the back end during the distribution phase, a net benefit to her of $149,500.
You can clearly see why that rule of thumb about Roth IRA conversions generally holds true.
In the first scenario, some may argue she could have converted the entire $100,000 into the Roth and paid the $33,500 in taxes from another account rather than withholding it from the conversion itself. True, but the counter argument would be, wherever she took that $33,500 from (like a savings account for example), could have been invested rather than used to pay taxes.
Bear in mind, this was a very simple example, with only one conversion being done over a lifetime. In reality, there are usually multiple conversions of varying amounts to consider and calculate.
Since Sara in this example is fictional and you are not, the original question comes right back to you: To convert or not to convert? And if so, how much and how often?
Call, email or text me and I’ll be happy to discuss with you.
Ryan Page, CFP®, MBA®
Office & Text:720-826-1092
Content in this material is for general information only and not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly.
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
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 is a hypothetical example and is not representative of any specific situation. Your results will vary. The hypothetical rates of return used do not reflect the deduction of fees and charges inherent to investing.
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