The Case for Roth Conversions through 2025: Maximizing Tax Savings for Federal Government Employees and Retirees
By: Katelyn Murray, CFP®, ChFEBC®, FBS®, CFT-1™, ECA -
By Katelyn Murray-
Roth conversions are a bit of a hot-button topic as of late in our meetings with Feds. This makes sense, given the tax landscape we are currently facing, and the dawning realization among many that tax flexibility is one of the key pieces of a healthy, robust retirement plan. In this article, we’ll delve into why Roth conversions could make sense for this Feds right now, and how to get the most bang for your buck when it comes to this complex tax planning strategy.
Understanding the Landscape: Pre- and Post-TCJA Tax Rates
Before digging into the specifics of Roth conversions, it's essential to provide some examination of the reason that they’re more attractive now than they perhaps were in the past. For this, we’ll need to take a look at the current tax climate, namely the impending change that is going to impact Feds in 2026.
Implemented in 2018, the Tax Cuts and Jobs Act (TCJA) brought about significant alterations to tax brackets, providing temporary relief for taxpayers in the form of historically low tax brackets. These adjustments, however, are set to expire on December 31, 2025, at which point, we will revert to pre-TCJA rates unless further legislative action is taken between now and then.
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To illustrate the impact of this transition, let's compare the tax rates for 2024 with those projected for 2026:
| 2024 (TCJA) Tax Rate | 2026 (Post-TCJA Tax Rate) | Single | Married Filing Jointly or Qualifying Widow |
| 10% | 10% | $0 to $11,600 | $0 to $23,200 |
| 12% | 15% | $11,600 to $47,150 | $23,200 to $94,300 |
| 22% | 25% | $47,150 to $100,525 | $94,300 to $201,050 |
| 24% | 28% | $100,525 to $191,950 | $201,050 to $383,900 |
| 32% | 33% | $191,950 to $243,725 | $383,900 to $487,450 |
| 35% | 35% | $243,725 to $609,350 | $487,450 to $731,200 |
| 37% | 39.60% | $609,350 or more | $731,200 or more |
Source: The Tax Foundation (https://taxfoundation.org/)
As you can see, the increase in rates is projected to be quite drastic, particularly for those in the middle of the brackets, with the 22% bracket turning into the 25% bracket and the 24% bracket turning into the 28% bracket. If TCJA is allowed to sunset on 12/31/2025 as it is currently scheduled to, the resulting rise in post-TCJA tax rates will likely have a significant impact on retirement income strategies for federal government employees and retirees, many of whom are in the tax brackets most severely impacted by the change.
It makes sense, then, that we would look to Roth conversions as a way to shift assets from pre-tax to after-tax buckets while tax rates are low and Roth conversions are “on sale,” so to say. As a refresher, a Roth conversion is when you take a distribution from your Traditional IRA, pay taxes on the total amount of the distribution, and then immediately convert the distribution into a Roth IRA, so that it can grow tax-free in the Roth IRA ever after. If you are looking to convert pre-tax TSP funds, you’ll need to first do a nontaxable direct rollover from your TSP into a Traditional IRA and then convert the funds over to a Roth IRA in order to avoid a very nasty misreporting error that could jeopardize the legitimacy of your conversion (for more on that, check out Ed Zurndorfer’s article here).
Avoiding the “Widow Tax”
Roth conversions hold an unexpected benefit for the spouses of federal employees and retirees as well. In contrast to a Traditional IRA or pre-tax TSP in which each dollar is taxed as income upon distribution, the tax-free growth and distributions generated from Roth accounts can be particularly advantageous. This is especially pertinent since the surviving spouse will have to face the (unofficially named) “widow tax” that comes with switching from Married Filing Jointly to Single filer status following the death of their spouse. Single filers typically face much higher tax rates compared to Married Filing Jointly filers. By strategically incorporating Roth conversions into their retirement planning, Feds can provide their surviving spouses with a valuable source of tax-free income, bolstering their financial security in later years.
Reducing Future RMDs in Higher Tax Environments
Another compelling reason to consider Roth conversions through 2025 is the potential to lower Required Minimum Distributions (RMDs) in the future, especially when tax rates are anticipated to be higher post-TCJA expiration. According to The Secure Act 2.0 of 2022, the RMD age has been tiered as follows:
- If you were born before July 1, 1949, your RMD age is 70½.
- If you were born July 1, 1949 - December 31, 1950, your RMD age is 72.
- If you were born January 1, 1951 - December 31, 1958, your RMD age is 73.
- If you were born after December 31, 1958, your RMD age is 75.”
By proactively converting pre-tax retirement account funds into Roth IRAs, Feds can reduce the taxable portion of their retirement income, thus mitigating the impact of higher future tax rates on RMDs.
So, Roth conversions sound like they could be a good strategy, given the current tax climate. But how do we make the most of them while we can in 2024 and 2025, before tax rates (ostensibly) go up in 2026?
Fill Out Lower Tax Brackets with Roth Conversions
One of the primary advantages of Roth conversions lies in the ability to leverage lower tax brackets, especially in years where income may be lower or deductions higher. By strategically converting pre-tax retirement funds into Roth IRAs, Feds can effectively "fill up" these lower tax brackets, mitigating the tax burden on future withdrawals. This approach becomes particularly advantageous in 2024 and 2025, as taxpayers can capitalize on the comparatively lower tax rates before the anticipated increase in 2026.
The first step is to understand your estimated taxable income for the current tax year and where it places you in the federal income tax brackets and your state income tax brackets, if you live in a state that has state income tax. Let’s say you file taxes Married Filing Jointly and you and your spouse are looking at having roughly $140,000 in taxable income for 2024. If we consult the 2024 federal income tax rates chart above, we’d find that that puts you solidly in the 22% tax bracket, which spans from $100,525 to $201,050. If we take the top of the tax bracket and subtract it from your estimated taxable income for the year, we’d find that you could safely convert about $60,000 to a Roth IRA without exceeding the 22% tax bracket ($201,050 - $140,000 = $61,050).
Those who are looking to take a more aggressive Roth conversion strategy in the years leading up to TCJA’s expiration might seek to go even further and fill up the 24% bracket, since the jump from 22% to 24% isn’t as drastic as the jump from the 24% bracket to the 32% bracket. In this scenario, you’d take the top of the 24% bracket and subtract it from your current estimated taxable income to arrive at a conversion amount of roughly $240,000 ($383,900 - $140,000 = $243,900).
Retirees: Be Mindful of the Source of Supplemental Income
Federal employees planning to retire in 2024 or 2025, or those who are already retired, may have a unique ability to create an even larger “Roth conversion budget” by controlling their taxable income to the degree that they’re able. For example, if you normally take $60,000 out of your Traditional IRA or TSP to supplement income to supplement your pension and/or Social Security income, you could consider switching to pull funds out of a non-retirement brokerage account instead, since these distributions would not contribute to your taxable income for the year, thus allowing you to make a larger Roth conversion. It’s important to remember that any portion of the distributions from a non-retirement brokerage account that constitutes gain would be taxed as capital gain, which, as long as you’ve held the positions for at least one year, is only 15% -- much lower than most folks’ marginal federal income tax rate. The key here, though, is keeping taxable income low, to create more “room” for a larger Roth conversion prior to the increase in tax rates.
Optimizing Tax Efficiency: Paying Taxes from Taxable Funds
When executing Roth conversions, it's prudent to aim to pay the taxes due on the conversion from either cash savings or non-retirement brokerage accounts, if feasible. If you’ve got a high-interest CD maturing anytime soon, this could be a good use for those liquid funds. By covering the taxes due on the conversion from outside of the pre-tax retirement account, you ensure that the full amount of the conversion gets deposited into the Roth IRA, thus maximizing the long-term benefits of the conversion strategy. However, don’t immediately discount the viability of a Roth conversion strategy just because you can’t pay the taxes from outside your pre-tax retirement account. It may be that some amount of Roth conversion would be better than no conversion, especially in the face of rising tax rates.
In conclusion, Roth conversions through 2025 present a strategic opportunity for Feds to optimize their retirement income in anticipation of changing tax landscapes. By leveraging lower tax brackets, minimizing tax implications through smart financial planning, and capitalizing on the long-term benefits of Roth IRAs, Feds can enhance their financial security and leave a lasting legacy for their loved ones.
Roth conversions are a complex financial planning strategy. For that reason, we always recommend that you consult with a qualified, fed-focused financial advisor and tax professional to assess individual circumstances and tailor a Roth conversion strategy that aligns with your specific retirement goals and objectives before taking any action. If you need help, STWS has got you covered – email us at [email protected] to schedule your free financial planning consultation today.
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**Written by Katelyn Murray, CFP®, ChFEBC®, FBS®, CFT-1™, ECA. The information has been obtained from sources considered reliable but we do not guarantee that the foregoing material is accurate or complete. Any opinions are those of Katelyn Murray and not necessarily those of RJFS or Raymond James. Any information is not a complete summary or statement of all available data necessary for making an investment decision and does not constitute a recommendation. Investing involves risk and you may incur a profit or loss regardless of strategy suggested. Every investor’s situation is unique and you should consider your investment goals, risk tolerance, and time horizon before making any investment or financial decision. Prior to making an investment decision, please consult with your financial advisor about your individual situation. While we are familiar with the tax provisions of the issues presented herein, as Financial Advisors of RJFS, we are not qualified to render advice on tax or legal matters. You should discuss tax or legal matters with the appropriate professional. **
***Unless certain criteria are met, Roth IRA owners must be 59½ or older and have held the IRA for five years before tax-free withdrawals are permitted. Additionally, each converted amount may be subject to its own five-year holding period. Converting a traditional IRA into a Roth IRA has tax implications. Investors should consult a tax advisor before deciding to do a conversion.***
****The Thrift Savings Plan (TSP) is a retirement savings and investment plan for Federal employees and members of the uniformed services, including the Ready Reserve. The TSP is a defined contribution plan, meaning that the retirement income you receive from your TSP account will depend on how much you (and your agency or service, if you're eligible to receive agency or service contributions) put into your account during your working years and the earnings accumulated over that time. The Federal Retirement Thrift Investment Board (FRTIB) administers the TSP.****
About the Author:
Katelyn Murray is a CERTIFIED FINANCIAL PLANNER™ (CFP®) professional, a Certified Financial Behavior Specialist® (FBS®), a Certified Financial Therapist™ (CFT-1™), and an Equity Compensation Associate (ECA). A lifelong student, she also holds a Masters Degree in Business Administration as well as a graduate certificate in financial psychology and behavioral finance.
Katelyn has been helping Feds and contractors build the retirement of their dreams for almost a decade. Her unique approach merges financial psychology with traditional wealth management expertise to create an integrated financial planning approach that helps clients make the most of the one resource they can’t get more of: time.
Katelyn has appeared as a speaker on The W Pulse podcast, The Liquidity Event podcast, and has led multiple break-out sessions at national industry conferences. Here at STWS, she writes on financial planning and behavioral finance topics. When she’s not writing for our blog, you can find her serving as a financial advisor and Relationship Team Lead for our STWS clients.
