Case study: a $1.5 million 401(k)
Consider a married couple that retires at age 62 with $1.5 million held evenly between two traditional 401(k) plans. They have no pension and delay claiming Social Security until 70. With earned income at zero and benefits deferred, the couple occupies a relatively low tax bracket for eight consecutive years—an opportunity window ending the day the first RMD is required.
If they convert $100,000 annually from the traditional 401(k)s into a Roth IRA, taxable income after the standard deduction lands near $67,800. Federal tax on that amount is about $7,600, producing an effective rate close to 7.6%. Pushing the full $133,000 to the 12% ceiling would raise the federal bill to roughly $11,600, or about 9% effective. Importantly, advisors recommend paying the tax from a separate brokerage account; withholding from the converted funds would shrink the Roth balance and, for those under 59½, could trigger a 10% early-withdrawal penalty.
The contrast appears a decade later. Assuming moderate investment returns, the untouched 401(k) balance might grow to approximately $2.85 million by age 73. The IRS Uniform Lifetime Table would mandate an initial RMD of roughly $107,000. Adding an estimated $80,000 in delayed Social Security benefits, the couple’s gross income would exceed $187,000 before any interest, dividends or capital gains from taxable accounts. That level of income lifts them into the 22% bracket, exposes up to 85% of their Social Security to federal tax and triggers Income-Related Monthly Adjustment Amount (IRMAA) surcharges that raise Medicare premiums for the remainder of their lives.
Why timing matters
Bracket smoothing is time-sensitive because the flexibility to choose conversion amounts effectively disappears once RMDs begin. After age 73, the IRS requires minimum distributions from traditional retirement accounts each year, regardless of a taxpayer’s willingness or need to spend the money. Any Roth conversion performed after the RMD must occur on top of that mandated withdrawal, potentially forcing a portion of the conversion into higher brackets.
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Moreover, the multidimensional nature of the tax code compounds the impact. A larger RMD can increase adjusted gross income, which in turn raises the percentage of Social Security benefits subject to tax under the provisional income formula. Higher adjusted gross income also moves retirees into thresholds where Medicare Part B and Part D premiums rise in stepped increments. According to the Social Security Administration, those surcharges are recalculated annually, so crossing a threshold even once can elevate healthcare costs for an entire year.
Guidelines for implementing the strategy
Advisors who support bracket smoothing generally follow several guidelines:
- Estimate future RMDs by projecting the account’s growth through age 73 using reasonable return assumptions.
- Model anticipated Social Security benefits and the age at which each spouse will claim.
- Determine the amount of Roth conversion that fills, but does not spill over, the desired bracket—most commonly the 12% range for joint filers.
- Use funds in a taxable brokerage account to cover the conversion tax, preserving the full converted amount for tax-free growth.
- Revisit the plan annually; investment performance, tax law changes or unexpected income can alter the optimal conversion amount.
Potential trade-offs
Although bracket smoothing can lower long-term taxes, it is not universally appropriate. Converting too aggressively could cause taxpayers to lose eligibility for certain deductions or credits that phase out at higher income levels. In addition, state income taxes may apply to Roth conversions immediately, whereas withdrawals taken in retirement might be exempt in states that do not tax retirement income. Carefully weighing federal savings against possible state costs is therefore essential.
Furthermore, the benefit of paying tax early depends on the spread between the current and future marginal rates. Individuals who anticipate lower income throughout retirement, or who expect to leave the balance to heirs in lower brackets, may derive limited advantage from conversions. Legislative risk also exists; future tax brackets could be altered by Congress, potentially changing the comparative benefit.
Key takeaway
For retirees holding substantial pretax balances, partial Roth conversions executed during the gap between the end of work and the start of required minimum distributions can mitigate the combined effect of higher brackets, Social Security taxation and Medicare surcharges. By intentionally filling the 12% bracket each year, many households can preserve more of their retirement income and reduce lifetime taxes. The strategy’s effectiveness, however, hinges on careful annual calculations and the availability of non-retirement funds to pay the associated tax bill.
