Advanced Planning Strategy: Partial Roth Conversion - A Whole Financial Strategy

Executive Summary

The Partial Roth IRA Conversion Idea

A Partial Roth conversion strategy involves converting portions of a traditional, pre-tax IRA to a Roth IRA over several years to manage immediate tax liability and potentially stay within lower tax brackets. This approach allows investors to spread out the tax impact rather than facing a large, single tax bill at once.

The First Why: Why Convert to a Roth IRA?

• Secure a nontaxable retirement income source - funds/assets within a Roth IRA can grow tax-free
• Qualified distributions - funds/assets within the Roth, once the five-year rule is satisfied, distributed after age 59 ½ are tax-free
  • Every dollar of appreciation, interest, and dividend earned in the account is the account owner’s/holder’s to keep
  • A powerful attribute to preserving wealth – if a higher tax bracket is expected in retirement, or rising rates are expected across the board – Roth conversions allow you to “pay the tax now” in exchange for tax-free income later (assuming timing and age requirements met).
• Roth IRAs are not subject to Required Minimum Distributions (RMDs) during the original owner’s lifetime.
  • Traditional IRAs require mandatory withdrawals starting at age 73 (or 75 under the SECURE 2.0 Act), which may cause retirees to withdraw more money than needed and result in higher taxable income.
  • With a Roth IRA, flexibility is the by-word – money can grow without required distributions - plus for long-term care planning or leaving assets to heirs.
  • Estate Planning help – A Roth IRA can be a valuable estate planning tool, even with the new requirements for most beneficiaries—adult children and grandchildren—which eliminate the "stretch IRA" strategy of extending distributions over the beneficiary's lifetime and instead require the inherited IRA to be emptied within ten years.
  • Within those 10 years, the heirs can receive tax-free distributions – a meaningful result for adult children in high tax brackets.
• Strategic retirement tool:
  • Tax diversification of retirement assets to support the flexibility of retirement asset growth and distribution.

There may be low-income years after retirement, but before RMDs and Social Security are triggered, so consider converting traditional assets at relatively tax rates

The Second Why: Why Consider a Partial Roth IRA Conversion?

• Manage Taxes – Avoid a large tax liability in a single year and/or being pushed into a higher, unwanted tax bracket triggered by a full or large conversion. Utilize lower tax brackets first.
• Manage Cash Flow – Avoid a cash flow crunch that a full or large conversion might cause.
• Manage Possible “Collateral Damage” – A full or large conversion could phase out valuable tax deductions or credits, increase taxes on Social Security benefits, and potentially raise future Medicare premiums due to Income-Related Monthly Adjustment Amounts (IRMAA).
• Manage Planning with Flexibility – Provides greater control over the timing and amount of income in retirement.

Putting the Strategy into Practice

Example:

Full Roth IRA Conversion

Frank and Lily's current combined income after deductions is $76,000, putting them in the 12% tax bracket. They have a $650,000 IRA that they are considering converting to a Roth IRA to avoid what they anticipate will be a future marginal tax rate of 24%.

If they convert the entire account, their taxable income increases to $726,000, pushing them into the 35% tax bracket. The conversion looked attractive initially—converting at 12% today to avoid a future 24% rate—but it loses its appeal when approximately $213,550 of the conversion crosses into the 35% bracket. This is a significantly higher rate than the future rate they were attempting to avoid. Would the better choice have been to leave those funds in the traditional IRA and distribute them later at potentially lower tax rates?

Partial Roth IRA Strategy Alternative

1. A Partial Roth Conversion can allow taxpayers to create just enough income to remain within the lower tax brackets while stopping before reaching the higher brackets. Again, Frank and Lily's combined income after deductions is $76,000, placing them in the 12% marginal tax bracket. They could convert as much as $24,800 more and remain within that 12% bracket, which tops out at $100,800 for married couples filing jointly in 2026.
2. Alternatively, they might choose to convert as much as $211,400, filling the remainder of the 12% bracket and all of the 22% bracket, while stopping before reaching the 24% marginal tax bracket. By using this strategy, they avoid the higher tax brackets today while also avoiding an anticipated future tax rate of 24% on those converted dollars, instead paying taxes at today's 12% and 22% marginal rates.

The reality is that there is only so much room available within the lower tax brackets before moving into higher tax brackets, which means a significant portion of the IRA may remain in traditional pre-tax form. However, given a long time horizon before they need to access all of their IRA assets, they might consider repeating the Partial Roth IRA Conversion strategy over several years.

Compliance Considerations

• This strategy may not be appropriate for all clients. Recommendations should be based on a comprehensive review of the client’s financial situation, including income, tax status, time horizon, liquidity needs, and overall financial objectives.
• Future tax rates, laws, and individual circumstances are uncertain and may change. The anticipated benefits of a Roth conversion strategy are not guaranteed and depend on future legislative and economic conditions.
• Clients should ensure they have sufficient liquidity outside of retirement accounts to pay conversion-related taxes and meet short-term financial needs. This strategy is generally more appropriate for clients with a longer investment horizon.

Key Takeaways:

The Partial Roth IRA conversion strategy allows the Traditional IRA holder to keep the benefits of an IRA with the most attractive feature of a Roth IRA – tax-free growth and withdrawals (assuming the 5-year rule is met, and distributions are made after age 59 ½ while avoiding what may be for the IRA holder an unmanageable tax liability. It spreads the tax impact of the Roth IRA conversion planning strategy.

Using a Partial Roth conversion, the Traditional IRA can take advantage of Roth IRA tax attributes while keeping conversions to amounts to avoid hitting higher income tax brackets. Like most tax strategies and financial planning and life – it’s all about balance. It would appear that the optimal balance is when the converted amount is minimized to avoid higher rates today, without being so small as to unnecessarily push the leftover account balance and growth into top brackets in the future. But of course, “balance” and objectives are client-specific – it is important for anyone contemplating this strategy to speak to their legal/tax/financial advisors to see if it fits for them.

Disclosures

This material is for informational or educational purposes only and not intended to provide legal, tax or investment advice.

Any examples are hypothetical and do not represent the results of any specific individual or account. Actual results will vary based on individual circumstances, tax laws, and other factors. Individual results will vary, and clients should consult a tax professional.

Information related to tax or estate planning is not intended as tax or legal advice.

Individuals should consult with a qualified tax professional, CPA, financial advisor, or attorney to evaluate how a Roth IRA conversion strategy fits their specific financial situation. All investing involves risk, including possible loss of principal.

Axonic Insurance refers to a group of affiliated legal entities organized under Axonic Insurance Holdings Inc. that collectively specialize in designing, distributing, and servicing annuity and other investment products for individuals and institutions worldwide. Axonic Insurance Services LLC ("Axonic"), an insurance producer licensed in all fifty states and the District of Columbia, #3003019286 in Arkansas, and #6013523 in California, acts as a business process outsourcer, including for the US-issued annuities underwritten by its non-affiliated carrier, AmFirst Insurance Company (NAIC #6025), an Oklahoma domiciled life insurance company with a home office in Oklahoma City, Oklahoma ("AmFirst"). AmFirst operates as AmFirst Life Insurance Company in California. AmFirst is licensed in 47 states, the District of Columbia, Puerto Rico, and the British Virgin Islands. Axonic Services LLC, a Puerto Rico limited liability company for profit, services the non US-issued annuities underwritten by its affiliated underwriter, Axonic Insurance Company SPC, a Class B(iii) insurer in the Cayman Islands licensed under the Cayman Islands Insurance Act, 2010 (as amended), as well as its non-affiliated carrier, AmFirst Life Insurance Company I.I., a corporation licensed as a Class 5 International Insurer and Segregated Assets Plan Company under Chapter 61 of the Insurance Code of Puerto Rico. Axonic has ownership interests in segregated accounts of ALIC, which provide reinsurance coverage to AmFirst and other third-party insurers.

0526-0030