Roth Conversion Calculator Methodology
General Context
The Roth Conversion Calculator (RCC) is designed to help investors understand the key considerations in evaluating the conversion of one or more non-Roth IRA(s) (i.e., traditional, rollover, SEP, and/or SIMPLE IRAs) into a Roth IRA, but it is intended solely for educational purposes – it is not designed to provide tax advice, and the list of factors included in the calculation is not exhaustive. Factors not considered in the RCC that may have an effect on Roth conversions include, but are not limited to: Alternative Minimum Tax, the impact of itemization of deductions on federal income tax, federal and state estate/inheritance tax, Social Security benefit eligibility and taxation, the out-of-pocket cost of Medicare and related services, financial aid eligibility, the exclusion of retirement income sources from income tax in certain state and local jurisdictions, and issues related to the taxation of US taxpayers residing abroad. Since one or more of these may be relevant to a given investor’s situation, users of the RCC should consult with a tax professional before taking any action – or deciding to forgo any action – with regard to the conversion of non-Roth IRAs into Roth IRAs.
Users of the RCC should also understand that evaluating a Roth conversion involves the use of estimates for a variety of future values (e.g., investment returns, an investor’s future income, tax rates and rules in the future) that cannot be projected with certainty. As a result, Roth conversion is inherently uncertain, and users are urged to consider not a single outcome but rather the full range of possibilities shown, since there is no way to know in advance what outcome will be realized.
User Inputs
- “How much money are you considering converting?” [The value entered is hereafter referred to as ConvertBal]
Note that this amount could be, but doesn't have to be, equal to the entire balance of all your non-Roth IRA(s). - “Have you ever made a non tax-deductible contribution to your non-Roth IRA(s)?”
If you have ever made a non tax-deductible contribution to any non-Roth IRA, or if you have inherited (and treat as your own) a non-Roth IRA from a spouse to which he/she made non tax-deductible contributions, you should select YES; otherwise select NO. Note that if you’re unsure about past non tax-deductible contributions, check form 8606, which may be included with your tax return – any non tax-deductible contributions, current or past, should be listed on this form. - “How much basis (total of all non tax-deductible contributions) is in your IRA(s)?” [Basis]
Include any non tax-deductible contributions you've ever made to any non-Roth IRAs, but only if they're registered to you. This means you should ignore non tax-deductible contributions made to inherited IRAs, unless it's one inherited from a spouse that you have decided to treat as your own. Note that this is asked only if the answer to #2 is YES. - “Including the IRA(s) you’re planning to convert, what is the total combined balance of all of your non-Roth IRAs?” [TotalTradBal]
This should include the total balances in all non-Roth IRAs registered in your name. Do not include Roth IRAs, IRAs held by your spouse, inherited IRAs (unless you've decided to treat as your own a non-Roth IRA inherited from your spouse). Note that this is asked only if the answer to #2 is YES. - “What is the investment style of your non-Roth IRA?” [Trad_TAM]
Investment style, also known as a Target Asset Mix or TAM, refers to the asset allocation strategy used in the non-Roth IRA that may be converted (note that since conversion does not affect the TAM, this is also assumed to be the TAM of the Roth IRA). Choose the asset allocation strategy from the list below that comes closest to representing the mix of investments held in the non-Roth IRA(s) that you are considering for conversion to a Roth IRA. Note that this is only designed to be an approximation. - “If you decide not to convert, and instead invest the money that would have been used to pay the applicable tax on the conversion in a taxable account, what investment style do you think you would use?” [Taxable_TAM]
Investment style refers to the asset allocation strategy, also known as a Target Asset Mix or TAM, for the taxable account to which you will assign your conversion cost assets if you elect not to convert. Choose the asset allocation strategy from the list below that comes closest to representing the investments in your taxable account. Note that this is only designed to be an approximation. - “What federal tax bracket are you currently in?” [Convert_FedBracket]
This should not be the average federal tax rate that you pay on all of your income, but rather the marginal rate, meaning the rate you would pay on an additional dollar of income. This is also known as your federal income tax bracket. Note that if your conversion is large enough, it can force you into a higher income tax bracket, i.e., increase your marginal tax rate. In general, it's a good idea not to do so - instead, consider restricting the size of your conversion such that it does not force you into a higher tax bracket. If you still want to convert more, you can perform conversions again in later years. The rates provided include all of the federal tax rates currently applicable (as of 11/2023) for individuals and households, both with and without the 3.8% Medicare surcharge (depending on the level of net investment income, this surcharge may be applicable to the income of individuals with MAGI over $200,000 and those married filing jointly with MAGI over $250,000).Source: IRS and Fidelity Investments - “What state/local tax bracket are you currently in?” [Convert_StateLocBracket]This should not be the average state/local tax rate that you pay on all of your income, but rather the marginal rate, meaning the rate you would pay on an additional dollar of income. This is also known as your state/local income tax bracket. Note that the number should be rounded to the nearest percent, and values are provided from 0% to 15%.
Note that if your conversion is large enough, it can force you into a higher income tax bracket, meaning that it can increase your marginal tax rate. In general, it's a good idea not to do so - instead, consider restricting the size of your conversion such that it does not force you into a higher tax bracket. If you still want to convert more, you can perform conversions again in later years. - “How many years do you plan to keep your savings invested before making withdrawals?” [InvHorizon]
For the purposes of the analysis, the tool assumes that Roth and traditional assets are invested in an asset mix based on your response and then fully withdrawn at the end of this time horizon. Our methodology assumes that if the conversion is not done, the taxable assets that would be used to pay the conversion tax bill are invested at an asset mix based on your response to the question within the tool, "Assuming you'll use cash on hand to pay taxes for the conversion, what would you do with the cash if you decided not to convert?", and withdrawn at the end of the time horizon. - “What federal tax bracket do you think you’ll be in when you begin to make withdrawals from the IRA you’re considering converting?” [Withdrawal_FedBracket]
This should not be the average federal tax rate that you think you’ll pay on all of your income, but rather the marginal rate, meaning the rate you would pay on an additional dollar of income. This is also known as your (federal) income tax bracket. Note that if your withdrawal is large enough (and you haven’t converted), the withdrawal itself can force you into a higher income tax bracket, meaning that it can increase your marginal tax rate. In general, it's a good idea not to do so - instead, consider restricting the size of your withdrawals such that it does not force you into a higher tax bracket. The rates available include all of the federal tax rates currently applicable (as of 11/2023), and scheduled to remain in place through 2025, for individuals and households (these are displayed in Item 7, above), as well as those that will apply starting in 2026, assuming the Tax Cuts and Jobs Creation Act expires as currently scheduled. Again, this list includes rates both with and without the 3.8% Medicare surcharge (depending on the level of net investment income, this surcharge may be applicable to the income of individuals with MAGI over $200,000 and those married filing jointly with MAGI over $250,000). Finally, note that these values are provided in 2024 dollars – they would be adjusted for inflation over time.Source: IRS and Fidelity Investments - “What state/local tax bracket do you think you’ll be in when you begin to make withdrawals from the IRA you’re considering converting?” [Withdrawal_StateLocBracket]
This should not be the average state/local tax rate that you pay on all of your income during withdrawals, but rather the rate that would apply to withdrawals from your IRA(s) if you decide not to convert them. As you think about this, consider that if you're planning to move to another state before or at retirement, the rate you enter here should probably reflect the tax rates in the state you'll be moving to, not the one you're in now.
Key Assumptions
Portfolio Return
Each of the hypothetical TAMs, or investment styles, comes with a different expected rate of return used in the calculation. In mathematical terms, this value corresponds to the geometric growth rate, sometimes also referred to as the compound rate of return.
It is of course impossible to know in advance what the returns to any given investment will be, and these hypothetical portfolio return values should be regarded as the estimated medians of returns that may have a wide range, depending on the overall allocation of the portfolio. Therefore, even if an estimated median is correct, the actual returns experienced may be considerably higher or lower than the values used in the RCC. Also, while these values – based on proprietary Fidelity research – are representative of different combinations of investment products that are broadly similar based on their asset allocations, there may be considerable variation in the returns of two different portfolios even though both may be aptly described as using, for example, the Balanced TAM/investment style.
The portfolio return for the TAM selected by the user for the non-Roth IRA, called Trad_TAM, is referred to in formulas below as IRA_Comp. So for example, if the Trad_TAM is Moderate, the IRA_Comp would be 6.71%.
The portfolio return for the asset allocation selected by the user for the taxable account (if not used to pay the tax on the converted amount), called Taxable_TAM, is referred to in formulas below as Taxable_Pretax_Comp. So for example, if the Taxable_TAM is Moderate, the Taxable_Pretax_Comp would be 6.71%.
Tax Efficiency Ratio (TER)
In the case of investments held in a taxable account, investment returns will be reduced by the effects of taxes incurred on: (1) distributions of dividends and income, (2) capital gains resulting from turnover, rebalancing and other portfolio activities over the course of the investment horizon, and (3) capital gains realized on liquidation at the end of the investment horizon. The return earned after accounting for all three of these is called the after-tax return, and the ratio of the after-tax return to the (pretax) portfolio return for the taxable account (Taxable_Pretax_Comp) is known as the Tax Efficiency Ratio, or TER. For purposes of the RCC, TER is a function of three factors: Taxable_TAM, Combined_Conversion_Rate, and InvHorizon. Note that the TER values are computed using a number of simplifying assumptions – these include the use of a single marginal tax rate over the entire horizon, unvarying investment returns, and constant asset allocation – and it is possible that the use of these simplifying assumptions would have a material impact on outcomes under unusual circumstances. Also, in theory, there would be a different unique TER value for each possible combination of Taxable_TAM, Combined_Conversion_Rate, and InvHorizon, but in practice the RCC uses an approximation by selecting the closest possible value from a precomputed array – one array for each Taxable_TAM. The arrays of precomputed TER values are as follows:
Description of the Calculation Process
The Roth Conversion Calculator operates by comparing the final, post-tax values of the assets under consideration given two distinct scenarios:
The With Conversion Scenario
Under this scenario, it is assumed that a given balance held in a non-Roth IRA (ConvertBal) is converted into a Roth IRA, and the income tax liability incurred by doing so is paid using funds that are immediately available and unencumbered by income tax/penalties, taxes on unrealized capital gains, back-end loads, or other liquidation costs (this generally means the assets required to pay for conversion are available as cash or money market funds held uninvested in nonqualified investment accounts, or in checking or savings accounts). Note that the tax rate applied to the conversion (Combined_Conversion_Rate) always reflects the rates selected by the user, even if the conversion amount is so large that it might force the user into a higher tax bracket. As noted above, it is generally advisable to limit the amount of a conversion so as to remain within the tax bracket that would otherwise apply.
Following conversion to Roth, the value of the IRA grows at a deterministic rate dictated by the user’s selected investment style (IRA_Comp), over a period determined by the length of the investment horizon (InvHorizon). At the end of this horizon, the account will have grown to its final value (Final_IRA), which is then liquidated. It is assumed that withdrawals are qualified under the applicable rules for Roth IRAs1, meaning that they are not subject to any taxes or penalties. If the asset were liquidated, for example, before the investor reaches age 59.5 and none of the other qualifying conditions apply, then the results shown by the RCC would be invalid because at least part of the Roth IRA balance may be subject to taxes and penalties when withdrawn.
On the Conversion Analysis screen, the final value (Final_IRA) displayed in bold green type as the “With Conversion” value. Note that this value is displayed in nominal, rather than inflation-adjusted terms.
The Without Conversion Scenario
Under this scenario, it is assumed that a given balance held in a non-Roth IRA (ConvertBal) is not converted into a Roth IRA, and assets corresponding to the income tax liability (Taxable_Balance) that would have been incurred by doing so is instead invested in a taxable account. The Traditional IRA grows at the same rate (IRA_Comp) over the same period (InvHorizon) as under the Conversion Scenario; at the same time, the assets invested in the taxable account grow at a rate that is determined by: (1) the rate of return (Taxable_Pretax_Comp) associated with the TAM assigned to the taxable account (Taxable_TAM), and (2) the applicable tax efficiency ratio (TER).
At the end of the investment horizon, both the non-Roth IRA and the taxable account are liquidated, and all taxes due are paid out of the proceeds. In the case of the non-Roth IRA, taxes due are a function of the final value of the non-Roth IRA (Final_IRA), reduced for any applicable basis (Comp_Basis), and the combined marginal tax rate applied to withdrawals (Combined_Withdrawal_Rate). Taxes on the taxable account due to liquidation are included in the TER, so thus do not need to be computed separately. Like the With Conversion Scenario, the Without Conversion Scenario always uses the tax rates specified by the user, even though large, rapid withdrawals from the Traditional IRA might have the effect of forcing the user into a higher tax bracket. Like large conversions that force the user into a higher tax bracket, withdrawals from an unconverted Traditional IRA that are large enough to push the user into a higher tax bracket are typically best avoided.
The sum of the final value of the two accounts, less the taxes due, is displayed in bold blue type as the “Without Conversion” value. Like the “With Conversion” value, the “Without conversion” value is displayed in nominal, not inflation-adjusted terms.
1A distribution from a Roth IRA is tax-free and penalty-free provided that the 5-year aging requirement has been satisfied and at least one of the following conditions is met: you reach age 591/2, suffer a disability, make a qualified first-time home purchase (up to $10,000), or die.
The Chart
As stated above, the evaluation of Roth conversion is inherently uncertain because of the impossibility of predicting the future value of income, tax rates, investment returns, etc. Therefore, users should always consider the sensitivity of any given pair of “With Conversion” and “Without Conversion” values to the inputs. One of the most important inputs – and one of the most difficult to predict with accuracy – is the tax rate that will apply to withdrawals (assuming there is no conversion) in the future. Therefore, the RCC provides a chart that provides “With Conversion” and “Without Conversion” values for all federal tax rates possible under current law (as of 11/2023) – note that the higher the assumed future tax rate, the more advantageous a Roth conversion tends to be (and vice versa).
Formulas for the Calculation Process
To perform the calculations needed to evaluate a Roth conversion, a number of intermediate values are needed in addition to the User Inputs and Key Assumptions listed above. They are as follows:
The final value of under both the Conversion Scenario and the No Conversion can then be calculated as follows:
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