As the calendar year winds down, many individuals consider strategic financial moves, one of which is the Roth IRA conversion. While this move can provide long-term tax benefits, it also comes with significant short-term financial implications that warrant careful consideration. Understanding how a Roth IRA conversion affects your adjusted gross income (AGI) is crucial for anyone contemplating this move, as it could inadvertently lead to several tax consequences.
A Roth IRA conversion entails transferring funds from a traditional IRA—either pretax or nondeductible contributions—into a Roth IRA. This financial strategy allows individuals to benefit from future tax-free growth on their investments. However, it’s important to note that the total amount converted is added to your current-year AGI. As highlighted by financial experts, this increase in income can have “unintended” consequences that one might overlook in a rush to secure tax-free growth.
JoAnn May, a certified financial planner and CPA, emphasizes that individuals must remain vigilant about their AGI as various tax break eligibility criteria hinge upon it. Consequently, higher AGI may result in the loss of access to certain deductions and credits, demystifying the initially appealing allure of a Roth conversion.
One particularly prevalent consideration centers around Social Security benefits. According to May, once a person’s AGI surpasses a specific threshold, they may be taxed on up to 85% of their Social Security benefits. This can significantly alter financial expectations for retirees, particularly those who rely heavily on this income stream for day-to-day living expenses. As a result, anyone contemplating a Roth conversion should carefully evaluate their current income and anticipated changes due to the conversion before proceeding.
Another critical dimension involves medical expense deductions, which also hinge on AGI levels. For the upcoming tax year of 2024, individuals may deduct unreimbursed medical expenses that exceed 7.5% of their AGI, albeit only if they itemize their deductions. This stipulation further complicates the decision-making process regarding Roth conversions, demonstrating how an AGI increase could potentially mitigate the tax benefits of such deductions.
For those nearing Medicare eligibility or currently enrolled, an increase in AGI can result in significant spikes in premium costs. This is particularly important given that Medicare premiums are influenced by an individual’s modified adjusted gross income (MAGI), which includes AGI plus any tax-exempt interest. Notably, there’s a two-year lookback period for the Income-Related Monthly Adjustment Amount (IRMAA), meaning that one’s AGI in 2024 could directly affect their Medicare premiums in 2026.
As noted by Ashton Lawrence, a CFP and director at Mariner Wealth Advisors, small changes in income can lead to surprisingly large increases in premium costs. This underlines the importance of being strategic about financial choices, particularly Roth conversions that can inadvertently push an individual over income thresholds.
Individuals obtaining health insurance through the marketplace must also keep AGI in mind due to the premium tax credit. This subsidy, which helps reduce health insurance costs, has been enhanced through 2025, benefiting a large percentage of enrollees. However, crossing certain income thresholds can affect eligibility and thus the overall affordability of healthcare plans.
According to data from the U.S. Centers for Medicare and Medicaid Services, nearly 19.7 million marketplace enrollees benefited from advance premium tax credit payments that lowered their annual insurance premiums significantly. However, if a Roth conversion results in a higher AGI, it could jeopardize access to such credits, leading to increased out-of-pocket expenses.
Roth IRA conversions can present an appealing opportunity for future tax-free growth; however, they can also complicate current tax situations in ways that are not readily apparent. Those looking to convert should carefully evaluate their entire financial landscape, from Social Security implications to Medicare premiums and healthcare credits. Engaging with a qualified financial planner can be invaluable in mapping out a strategy that aligns with both short-term needs and long-term goals, ensuring that unexpected tax consequences do not overshadow the advantages of a Roth conversion.