The Tax Planning Window and Partial Roth Conversions for “401k Millionaires” – The White Coat Investor

[Editor’s Note: Today’s guest post is from Infectious Disease physician David Graham, MD, who blogs at  After discovering his passion for personal finance, he started a Registered Investment Advisory to promote “Financial Literacy for Physicians.”  We have no financial relationship. The post today is about “The RMD Problem,” which is generally overblown. However, if one actually does have an RMD problem, the solution is Roth conversions as discussed in this post. ]

Employed physicians and other high-income folks are frequently “401k Millionaires.” We earn good money and during our peak income years, when we are in high-income tax brackets, it makes sense to defer income into 401k, 403b, or 457 plans.

We think of this money as our nest egg for retirement, but the IRS calls it IRD (income in respect to the decedent) and wants to crack that egg open to suck out taxes on the deferred income inside.

“Tax bracket arbitrage” makes a lot of sense (defer income when we are in high brackets until later when hopefully we are in lower tax brackets) but there are some important considerations. No one can predict future tax laws. If you are a 401k multi-millionaire, however, it makes sense to try and manage your future tax burden with the big picture in mind. What may be the sum of your tax payments now and in the future? Some may consider partial Roth conversions as a strategy to lower overall tax burden.

White Coat Investors are awesome accumulators. We know how to make money and where to put it.

Planning for de-accumulation (or distribution), however, is difficult for super-savers. We spend 20-40 years growing this egg, but what is the next step? Understanding RMD’s is important when considering spending your nest egg in retirement.

Required Minimum Distribution (RMD) Problem

Required Minimum Distributions (RMDs) start in the year you turn 70 and a half years old. You take the previous year’s December 31st IRA balance (assuming you roll over all of your deferred accounts into one IRA) and divide it by a denominator that can be found on the IRS’ Uniform Life Table.

Say you have been a good accumulator and have $2 million the IRS wants to tax. Doing the math from the table above, the IRS will force you to take out and pay taxes on about $75,000 that first year.  When you turn 90, that same $2 million will bleed out $175,000 of income for the IRS to tax.

Disability Insurance

Under some circumstances, folks will find themselves in the same or even higher tax brackets during retirement than when they deferred their income.  Well, shoot, that’s not such a bad problem to have, and one that Dr. Dahle calls a “First World Problem.”

However, it would be nice to control when you take income out of your deferred accounts, and retirement can be a window in time to take control of your future distributions rather than having the IRS force them out via RMDs.

Use Your Tax Planning Window to Lower RMDs

The Tax Planning Window is a window in time as you transition from accumulation to distribution. This window opens as soon as you stop earning income (and thus can access your lower tax brackets) and closes when you are forced to take RMDs.


Figure 1


As an example, a theoretical doctor’s income is represented above. Assume she is 55 years old, married, earns $400,000 a year, and wants to retire at 60. She and her husband currently have $1 million in a taxable account and $2.5 million in a 401k, which are both invested 70/30 in stocks and bonds, earning 8% and 3% respectively. She will continue to contribute to her 401k while working, and they have $100,000 in backdoor Roth IRAs. They spend a modest $150,000 a year and plan to continue spending that amount in retirement. They plan to fund their retirement from their taxable account to delay social security until their full retirement age of 67.

As this doctor retires at age 60, the light blue shows her income dropping down from above the 24% tax bracket (which becomes the 28% tax bracket in this example when the Tax Cut and Jobs Act of 2017 expires) into the 10% tax bracket. They continue to have capital gains and dividends from the taxable account.  There is a little bump in income when social security kicks in at age 67.  When RMDs kick in at age 70 and a half, note that they are quickly forced back above the 24% tax bracket.


Figure 2


The figure above shows what this couple’s expected cash inflows and outflows should be over time. Note these are net negative until age 70. Also, note the expected tax payments during the working years and then again when RMD’s kick in. Thus, there is an opportunity between retirement and RMDs to do some tax planning.

partial roth conversion

David Graham, MD

This window between accumulation and distribution–between income and RMDs–might be the time to consider Capital Gain Harvesting, but in this example, let’s look at the implications of partial Roth conversions.

Roth Conversions

A Roth conversion happens when you pay taxes on your tax-deferred account (IRA), and convert the money into a Roth IRA.

That’s it. It is not fancy. You now have Roth money–some of the sweetest currency around.

These partial conversions fill up your previously empty, lower tax brackets with income, so be careful not to overdo it, as you don’t want to pay more in taxes now than you would have otherwise done in a future without these conversions.

Back to the previous example, what if our retired doctor and her husband “fill up” their 10, 12, or sometimes even the 22 or 24% tax brackets with Roth conversions? What affect would that have on current, future, and total tax rates? Financial Planning Software can pinpoint the sweet spot of Roth conversions the next figure demonstrates.

roth conversions

Figure 3


In this example, we see the darker blue “filling up” to the 12% tax bracket. This represents “income” (or taxes paid) because of partial Roth conversions every year.

Notice what this does to the RMD’s, shown as the darker blue within the iceberg of the RMDs expected without partial Roth conversions. Instead of quickly going above the 24% tax bracket, they stay in the 22% tax bracket over time, lowering total taxes paid over their remaining life.  As an interesting twist, also note that between 67 and 70 our couple runs out of brokerage funds and is forced to start using tax-deferred money to fund their retirement. We can see these numbers below.


partial roth conversion

Figure 4


Note the partial Roth conversions between the ages of 60 and 66. This results in a large addition to their tax-free (Roth) account balance and rapid depletion of their taxable account, which are both funding retirement and Roth conversions.

Consider the conversion amounts above estimates and likely to be inaccurate, as year to year income is variable and will affect the amount you can convert and stay within a specified tax bracket. In addition, the Tax Cut and Jobs Act of 2017 is set to expire in 2026 making planning around that time a binary exercise (where you either plan for it to expire or not).  Each year conversions will need to be carefully planned as recharacterizations of Roth conversions are no longer allowed. You used to be able to convert extra money and later “undo” or recharacterize the conversion if you put too much in, but this has been disallowed making partial Roth conversions a more arduous yearly math puzzle. The fundamental math is straightforward, however: you just take the maximum dollar amount for the tax bracket you wish to fill and back out your adjusted taxable income and you get your conversion amount.

portfolio value

Figure 5


Not only does this lower total tax paid, but partial Roth conversions (seen on the left above) also result in a higher ending portfolio balance that is 46% Roth money. Compare this to no conversions (the right) with a lower ending balance, and of course less Roth money.  These account balances over time are demonstrated below.

Tax deferred vs taxable

Figure 6


For those of you interested in the “4% safe withdrawal rate” rule of thumb, the withdrawal rate from this fictional portfolio is demonstrated below.

4% safe withdrawal rate

Figure 7


Purpose of Partial Roth Conversions

In addition to a lower cumulative tax rate during your retirement, lowering your RMDs may also:

1) decrease the amount of taxes you pay on your social security earnings;

2) decrease the risk of higher Medicare premiums;

3) decrease the risk you’ll get stuck paying IRMAA for Medicare part B and D;

4) decrease your capital gains rate;  and

5) leave you less susceptible to the widow/widower tax penalty (lower tax brackets once your spouse dies). If you have enough income deferred, however, it is unlikely you will benefit from any but the last of these potential savings.

The main reason to do partial Roth conversions:  you get to keep more of the money you made.

Perhaps equally as important is that you leave a tax-free legacy to your children. Instead of your kids having to take “income” from your tax-deferred accounts–likely at their peak earning years–give them tax-free Roth money to enjoy.

What do you think? Have you done Roth conversions other than an annual Backdoor Roth IRA? Do you plan to at some point in your career or early in your retirement? Why or why not? Comment below!

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