“Despite the advantages of conversion, there isn’t always a clear-cut path when deciding whether to convert a traditional to a Roth IRA,” says Vanguard’s Joel Dickson, global head of advice methodology. “The traditional wisdom says to convert if you expect your tax rate to rise in retirement. And yet, a Roth conversion can be favorable for far more investors than this rule of thumb would suggest.”

Dickson and Vanguard wealth planning specialist Boris Wong champion the break-even tax rate (BETR) as a superior method for calculating the point at which a Roth conversion makes sense.

With the BETR approach, future tax rate expectations are but one factor in the conversion decision. The approach levels up the analysis by taking into account crucial factors like conversion-tax proceeds paid from account assets held outside the IRA, the tax basis of the IRA account, and future plans to contribute to the IRA (typically using a backdoor strategy).

At its most basic form, BETR is that future tax rate at which the after-tax withdrawal value for an investor would be the same in both the no-conversion and conversion scenarios.

In a sense, the conversion decision will depend on this single figure. If an investor’s future tax rate is greater than the BETR, it makes sense to convert; if the future tax rate is lower than the BETR, it doesn’t. 

Even better: The BETR is not a static number. There are investor choices that can lower the rate, and this, in effect, expands the pool of those who could ultimately benefit from the long-term tax advantages of a Roth conversion. Investors can:

Pay conversion taxes from a taxable account. Tapping into a separate cache of cash allows the full value of the IRA to move to a tax-advantaged account. The more tax-inefficient the account used to pay the conversion tax, the lower the BETR (and the greater the benefit of converting).

Invest over a longer time horizon. The longer the time frame, the greater the potential for Roth assets to compound tax-free, and the lower the BETR for Roth-converting investors who pay the conversion tax from taxable assets.

Use the Roth conversion as an opportunity to make future backdoor Roth IRA contributions. Only investors filing under a certain income limit qualify for Roth IRA contributions—but the two-step backdoor Roth conversion strategy is open to investors at all income levels. By using the backdoor method, you can contribute up to $6,000 ($7,000 if you’re 50 or older) to your Roth IRA each year. Over time, that adds up to a lot of tax-advantaged investment opportunities. And don’t forget to consider your IRA’s tax basis. Nondeductible contributions will not be taxed again during a Roth conversion. This, too, will lower the BETR. 

“The value of a Roth conversion is often underestimated and underappreciated,” says Wong. That’s because the tax benefits of a Roth account are difficult to capture fully with the traditional rule of thumb—or even with the more sophisticated BETR calculation. Those benefits include:

• Greater potential for tax advantages after the loss of a spouse. As of 2022, a couple with a $60,000 annual income falls in the 12% tax bracket, while a widowed single filer with the same income may land in the 22% bracket.

• Reduced required minimum distribution (RMD) demands. Roth IRAs have no RMD, and they are not subject to RMD rules during the owner’s lifetime.

• Enhanced flexibility around the Medicare and Social Security tax cliffs. Roth IRA withdrawals do not affect the taxable income levels that affect these benefits.

“Paying taxes now to avoid higher taxes in the future can be a valuable strategy for many investors,” Dickson says. “The BETR calculation can make a traditional-to-Roth conversion more accessible than the conventional analysis suggests.”