How to Optimize Roth Conversions: Why Timing is Important (Part Two)

In a previous Roth conversion article, we discussed the importance of timing. Roth conversions also offer other benefits, such as no required minimum distributions (RMDs) and the ability to withdraw qualifying contributions and conversions at any time.  However, you risk overpaying for that privilege.

Let’s imagine a household currently in the highest tax bracket (37%). They plan to eventually retire to the 15% tax bracket. A Roth conversion today would cost that household more than twice as much as waiting until they have to take RMDs. Conversely, a family currently in the 15% bracket might save thousands of dollars by maximizing conversions while in that bracket.

This article aims to discuss:

• Why a military family’s tax bracket might change over time
• When you might want to consider Roth conversions
• When you might want to delay Roth conversions
• Why you might want to hire a tax professional to help with tax planning
• Why you might never want to convert to a Roth account at all

First, a disclaimer: This article is for educational purposes. It is not intended to provide specific tax advice, strategy, direction or instruction. Each tax situation is unique and should be discussed at length with a tax professional. The information in this article is for educational purposes only, and should not be used as a reference. Although this article links to references as appropriate, tax authorities may change over time. Everyone should exercise due diligence before implementing a recommended tax strategy.

Why a Military Family’s Tax Bracket Might Change Over Time

Two primary reasons your tax bracket may change over time. Let’s call the first category “Things that are beyond your control and don’t directly impact you.” These are things that we cannot really plan for. This basically includes whatever Congress does (which isn’t a lot nowadays), future policy changes or unforeseen circumstances. It’s important to keep tabs on tax policy as it changes over time. You can’t really plan for it.

The second category would be “Things that you can control, or things that might directly impact you.” This includes promotions, career changes, lifestyle design, retirement and more. In other words, these are things that you can (or should) plan for. This also includes things you can’t control but that will impact you.

To contrast the two categories, let’s say the army plans to reduce its manpower by 10%. That may affect you, but you don’t know whether it will directly affect you. However, let’s say the army plans to cut promotions for pilots. If you’re a pilot up for promotion, you might want to plan for that contingency. In this article, we’ll focus on the second category.

So, why would a military family’s tax bracket change over time? Four overlapping trends (let’s call them lifecycles) explain this, and we’ll look at them. I’ll briefly outline them, but these are vague, general concepts. There are myriad exceptions, too numerous to note in this article.  However, I’ll try to outline a few in each instance. With that said, you might want to sit down and mentally map out how these trends affect your life.

Family life cycle: In the traditional sense, you grow up, move away from home, eventually get married, have children, raise them until they leave the house, and then become an empty-nester.

Today, the family life cycle isn’t nearly as straightforward. Divorces, boomerang children and middle-aged parents caring for both kids and aging parents are all the norm.

Debt lifecycle: Since the debt you carry directly affects how much you can save, it’s important to mention this. Usually, people graduate from high school with little or no debt. However, they might accumulate debt in the form of credit cards and consumer debt, car loans or student loan debt. Over time, they might pay it off and take out a mortgage to buy a house. Eventually, as they prepare for retirement, people try to minimize debt so their accumulated savings can support their quality of life.

Of course, outliers exist in both directions. Thanks to the internet, entire communities follow Mr. Money Mustache and Dave Ramsey, both of whom extol the virtues of living debt-free. Unfortunately, many more people struggle to get out of debt. This is especially true for people who overpay for college and graduate saddled with overwhelming student loan debt.

Economic lifecycle: Traditionally, people start with little or no income. After high school, they either go to college or enter the workforce straight into a low-paying job. As they accumulate experience and build their resumes, they increase their earning potential for as long as they remain in the workforce. Over a working career, earnings potential generally rises…someone working in an industry usually makes more in their 50s than in their 20s, especially if they invest in their career and stay relevant. At some point, they might retire, either for health reasons or to spend more time on personal interests.  As they retire, they may find their cost of living has decreased as they pay off loans or downsize the house where they raised a family.

This usually coincides with the family lifecycle, either by design or circumstance. Most people plan for retirement as their family and debt obligations decrease and they approach financial independence. However, many people decide to ‘off-ramp,’ whether to raise or care for family or as part of a lifestyle design. Conversely, some never retire, either because of passion or because they cannot afford to.

Military lifecycle: This seems like a subset of the economic lifecycle (if you work after the military, your military income and pension are only a subset of your entire earnings potential). However, there are enough military-specific items to warrant addressing them separately.

• Tax treatment: Generally, the military receives more favorable tax treatment than civilians. This is particularly true during combat zone deployments.
• Multiple moves: Since most military families move every two to three years, they usually have the opportunity to relocate to a state with low or no income tax.
• Promotion opportunities: Everyone starts off at the bottom (however, as an officer, my definition of the ‘bottom’ was much different from when I was enlisted). Over time, promotion opportunities allow service members to increase their compensation. Unlike the civilian world, though, you rarely take a pay cut (unless it’s punitive).

In order to fully understand the Roth conversion opportunities that lie before you, you probably should have a good idea of your current marginal tax bracket, and how you think it will change over time. Mapping out your life around these four concepts will help you identify opportunities to optimize your Roth conversions.

With this framework in place, let’s look at your life in one-year intervals. This way, we can evaluate each tax year and decide. Your decision is going to be simple:

• Make a Roth conversion until you reach the next tax bracket (or the next one after that)
• Push pause until next year

Remember, just because you don’t convert this year doesn’t mean you can’t reevaluate later. And you should. Even today’s 20-year retirees can have up to 30 years before they have to take RMDs from a traditional plan.

Let’s assume that our goal is to maximize Roth conversions at a lower (relative to the rest of your life) tax rate, and to avoid conversions at a higher rate. With that in mind, let’s look at when you should consider Roth conversions, and when you should avoid them.

When to Consider Roth Conversions

• When you’re in the 15% tax bracket or lower, always fill up to the next tax bracket. According to current tax rates, this includes the 10% and 12% brackets (which replaced the old 15% bracket under the Tax Cuts and Jobs Act). Check the IRS’s current tax brackets for this year’s exact income thresholds, since these are adjusted annually for inflation.

Using 2017 pay tables, most enlisted families and some junior officer households would qualify for the 15% tax bracket. Of course, this doesn’t include special pay, incentives, bonuses, or tax-free compensation for combat zone deployments, so you should factor those into your situation. It also doesn’t include deductions and exemptions, which you can guesstimate from your previous year’s tax returns. Finally, it also doesn’t include other circumstances we’ll discuss momentarily, so treat this as a starting point.

However, you shouldn’t blindly convert everything at once, especially if you have a large amount of money saved in a traditional account. By paying close attention to your LES, you can project how much of your IRA you can convert to a Roth before you hit the next tax bracket (25%).

• When you’re deploying for a significant time to a combat zone. What’s better than paying 0% on your income? Paying 0% on your income and paying 0% for a Roth conversion.

If you spent an entire calendar year in a combat zone, you would likely have zero taxable pay (unless you’re an officer whose compensation is more than that of the senior enlisted of any of the services). However, even if you had some compensation, you might still have zero taxable pay once you calculate exemptions and deductions. Once you add in credits, you’re looking at a significant amount of income that you won’t pay taxes on.

For example, an E-7 deploys to a combat zone for a full calendar year. He has a wife and three children, 12 and younger. Let’s assume he has no bonuses, incentive pay, or anything other than allowances and hostile fire pay/imminent danger pay. Assuming his wife does not work outside the home and they have no other sources of income, they will have:

• $4,050 in exemptions for each person (or $20,250 total)
• $12,700 in standard deductions (or more if they are able to itemize)
• $3,000 in child tax credit

Let’s consider this: There are $39,950 in exemptions and deductions, but no taxable income. That means you can convert at least this amount to reach zero. Every dollar above that is taxed at 10%. However, you have a $3,000 child tax credit, so you can convert another $30,000 before using the full credit. That’s almost $70,000 in conversions at a 0% tax rate.

This doesn’t even factor in the earned income tax credit, other income adjustments, itemized deductions (to the extent they exceed the standard deduction), or other credits. If you needed to convert more, this couple could add another $18,650 (at the 10% rate) or up to $75,900 (the first $18,650 at 10%, then the remainder at 15%). This would mean a total tax bill of $10,452.50 on $145,850, for an effective tax rate of 7.2%. If you needed to convert more than that, that’s not a bad problem to have today.

Obviously, this is an extreme example…most people will probably have some taxable income in each year since most deployments cover part of one year and into the next. Food for thought.

• When you’re exiting the military and NOT immediately taking a job. What happens when you exit the military? Most people get a job. Unless they don’t.

Many people decide to take a year off, go back to school, or retire permanently. If so, consider where your income will be compared to what it will be when you finish school or re-enter the workforce. If you retire permanently, consider your tax bracket and whether you can make reasonable conversions over time.

• When you move from a high-income tax state to a low (or no) income tax state. When calculating your Roth conversion liability, consider state tax implications as well.

For example, Maryland income tax is based on a sliding scale ranging from 2% to 5.75%. For a couple who is already making $50,000 per year, a $20,000 Roth conversion would cost an additional $950 in state taxes alone. If you expect orders to Florida (which has no state income tax), factor that into your tax planning.

If you’re planning to retire to a no-income-tax state, even better. Before you retire, you should at least have some idea of which states tax military pensions.

• If you’re getting a promotion pushing you into a higher tax bracket. This might not matter much for most enlisted families, or even junior officers. However, if you’re selected for promotion, you should see how that new pay grade will impact your future tax situation. Since this is a permanent (hopefully) pay raise, you’ll want to take advantage of your lower tax liability before your promotion.

When You May Want to Delay a Roth Conversion

Below are some areas where you might want to consider whether a Roth conversion is worthwhile. Most of these are taxable events that might push you closer to that next higher tax bracket. However, two caveats:

1. Just a consideration. It doesn’t mean that if one of these things holds true, you shouldn’t do a Roth conversion. However, you should take the time to understand the tax implications so you can decide what your Roth conversion should look like.
2. It’s not now or never. An event might lower this year’s conversion amount or push you out of your desired tax bracket. However, just because it happened this year doesn’t mean you can’t revisit it next year.

That said, let’s look at situations where you might want to hold off, or at least take a closer look.

• When you’re expecting a taxable bonus. For many people, this isn’t an issue. I went an entire career without worrying about extra money. However, if you’re in a career field that is bonus-heavy, you’ll want to consider the timing and amount of your bonus payments when making your Roth conversions, particularly if you’re close to the next tax bracket. This is particularly true for reenlistment and retention bonuses, where a significant amount might be paid up front, with the remainder spaced out over the remaining years.
• When you’re selling a rental property. I always advise people to have a CPA or enrolled agent prepare their taxes in the year they sell a rental property (sorry, H&R Block doesn’t cut it). When you sell a rental property, you’ll likely recapture depreciation that you were entitled to. This will impact your tax return. Calculating recaptured depreciation and the resulting tax liability isn’t straightforward. When selling a rental property and performing a Roth conversion, I highly recommend you consult a tax professional so that you can properly calculate how much you should convert (see below).
• This is especially important if you expect significant capital gains. Capital gains tax includes sales of property or investments and is captured under Schedule D on your tax return.  Although capital gains get preferential tax treatment, they still increase your taxable income, which directly affects your tax bracket & how your Roth conversion is taxed.  However, if you’re selling a home and the entire gain is eligible to be excluded under Section 121, this does not apply.
• When you’re retiring from the military, you’re taking a job where you expect higher income. That first year out of the military is pretty hectic. You’ve got a lot going on, and Roth conversions are probably the last thing on your mind. Since post-military life usually takes a year or two to feel normal, you’re likely to miscalculate that first year’s income and inadvertently overpay. You might consider maximizing your Roth conversions (if it makes sense) in your last full year, then taking some time to see where you end up, tax-wise.

If you end up in a permanently higher tax situation, that’s a good problem to have, and we’ll discuss your options below.

• When you’re relocating to a state with higher income taxes. This isn’t an all-stop. Instead, keep the implications of state income taxes in mind. If you might not want to establish residency in a no-income-tax state (a common reason is to get in-state college tuition for your children), you may want to pause and re-evaluate.
• If you have a combination of deductible and non-deductible IRAs to convert. This might happen to someone who diligently contributed to their deductible IRA and then reached the IRA deductibility limit. When this happens, you can still contribute to your IRA, even if you cannot deduct that contribution from your income.

While the IRS allows conversion of non-deductible IRAs (also known as ‘backdoor’ Roth IRAs), having pre-tax and non-deductible accounts creates some complexity. The IRA aggregation rule forces a pro rata conversion of ALL IRA accounts.

For example, let’s say you have $80,000 in a pre-tax IRA (you took deductions on your tax return) and $20,000 in a non-deductible (you did not deduct from your tax return) IRA. Let’s assume you want to make a Roth conversion of $10,000 this year. You cannot simply take $10,000 from the non-deductible IRA (which you already paid taxes on, and could consider a “back door Roth”). Instead, you must take a prorated portion from each account. In this case, that would be $8,000 from the pre-tax account and $2,000 from the non-deductible account. You would pay taxes on the $8,000 as part of the conversion.

Why you might want to hire a tax or financial professional.

• Tax planning. This article (over 3,000 words) is focused on one very small segment of tax planning. Tax planning isn’t very intuitive, and it can get messy. More importantly, it’s iterative. You have to keep updating your plan as your life changes.  Roth conversions are a central (but not the only) part of the tax planning process.
• Understanding what your tax liability SHOULD be. You can glean a lot from the crowd and form your own sense of what right looks like. However, WebMD is no substitute for an annual checkup with your doctor. Likewise, you will never see your tax situation from a professional view unless you hire a professional.
• Second set of eyes. Even if you’re 100% right, you’ll probably miss something. That simple omission could cost you hundreds (or thousands) of dollars.
• Tax-preparation software. The tax code is complex. TurboTax and H&R Block software does a good job for the average tax prep client (think 1040 EZ, no itemized deductions, no investments). However, as tax situations become more complex, the likelihood of errors and omissions increases. Tax practitioners use better tax software, not just for tax preparation, but for tax planning. This lets them help you plan your taxes with much greater accuracy.

Why You May Never Want to Convert to a Roth at All

There are many compelling reasons to convert your accounts to a Roth. However, there are important reasons to hold off. You may also choose not to convert at all.

• You’ll be in a permanently lower tax bracket than you are now. If you’re in (or planning to be in) the 28% or higher bracket, you should probably look at what your life will look like when RMDs hit. More likely than not, you’ll be in the 15% bracket, or fairly close to it. Do you really want to pay higher taxes now, just to avoid a 15% tax hit down the line?
• You might choose to take distributions before RMDs hit. There’s a nice window between ages 59 1/2 and 73 when you can take distributions, but don’t have to. If this window aligns with your retirement goals, taking distributions might let you retire earlier. After all, it’s taxed the same way as your wages…except you’ve already earned this money. You can also see this period as an opportunity to maximize Roth conversions at a lower tax bracket.
• You have charitable goals. For those who are charitably inclined, tax planning should be a focal part of your life. Not just to avoid paying taxes, but simply to put more of your money to work for the charitable efforts you want to support. One of the most powerful ways to do that is through Qualified Charitable Distributions (QCDs).

Simply put, a QCD is an otherwise taxable distribution from an IRA that is paid directly to the charity.  You don’t pay taxes on the distribution. A QCD can satisfy part or all of your RMD requirement (up to $111,000 annually as of 2026; this limit is now indexed for inflation). If you were already planning to give money to charity, it can’t get any better. You don’t pay taxes on the money as it goes in, grows in an IRA, or goes out.

• You’re planning for longevity. I generally don’t like annuities. With that said, I’m going to talk about them for a second. To accommodate the current aging trend, the insurance industry has created longevity annuity contracts (also known as qualified life annuity contracts or QLAC). When operating inside an IRA, a QLAC would allow the deferment of RMDs until up to age 85.

Why would you want to do this? You might not. After all, QLACs don’t avoid taxes; they simply defer them. However, an annuity’s purpose is to provide guaranteed income. For people worried about outliving their money (and who don’t expect to rely on their RMDs to support their active retirement lifestyle), a QLAC might be an option, especially as a hedge against long-term care expenses. This article doesn’t cover the benefits and drawbacks of a QLAC.

Consider each of these scenarios as you ponder Roth conversions. You may disagree with the premise, but you should at least consider how your life will change over 20, 30, or 40+ years. The most important question to consider is whether you’re paying taxes today that you could minimize or eliminate tomorrow. Just a thought.

Conclusion

Congratulations, you made it! Seriously, though, Roth conversions are a very tough part of tax planning. It’s easy to just plug away and convert to Roth accounts. However, if you want to make the most tax-efficient decisions, you’ll find that it’s harder than it looks.