Modeling Roth Conversions in Scenario Analysis

In Scenario Analysis, users can create a baseline and change subsequent scenarios to model how a Roth conversion would affect a client. This is the most precise way to model the tax impact of a Roth conversion.

Best practice: Set up a Baseline scenario that includes everything except the Roth conversion. Use the baseline to determine how much conversion to model. Once the Baseline is finalized and you have a conversion amount, copy the Baseline into a new scenario to model the conversion.

The Roth Conversion Worksheet can be found in the 1040 Income section. To access the Roth Conversion worksheet, click on the pencil icon in that row.

The worksheet allows a user to enter the total amount of Roth conversion across all taxpayers in a household or to segregate conversion amounts by taxpayer. A best practice is to always enter the conversion amount per taxpayer. Note that this is necessary for some state tax projections.

If the Roth Conversion (Override - All taxpayers combined) field has any data in it - including a "$0" - the Taxpayer 1 and Taxpayer 2 fields will be overridden by the value in the override field.

Once the amount of Roth conversion is entered, the worksheet will show the incremental tax cost of conversion, Roth conversion effective rate, and the marginal tax bracket after the Roth conversion.

Note that the Roth Explainer (premium feature) will only show if both taxpayers are included in the Filing Status section (if a joint scenario), and Roth conversions are entered per taxpayer, with no override.

The incremental cost of the conversion is shown both in dollar amount and effective rate. Under the hood, Holistiplan is calculating the tax with and without the conversion, so that we can show the cost of just the conversion itself. This not only shows tax on the amount conversion, but also any additional tax that results because of the conversion.

incremental cost = the total tax as a result of the conversion / total amount converted

If there is basis in the Traditional IRA, externally calculate the amount of the conversion that is truly taxable, as the Scenario Analysis tool cannot perform that calculation. Only enter the taxable amount of conversion in the Roth Conversion Worksheet.

To determine how much of a conversion to make, use the Solve for Max and/or Range Calc features on the Baseline scenario.

Solve for Max will indicate how much more ordinary income or capital gains income can be realized in a given scenario before there is an increase or decrease in the effective tax rate. This is not necessarily the same thing as a change in the marginal tax bracket (as seen in our example below).

After clicking on Solve for Min/Max, the scenario will take a moment to calculate and populate the values. In the example below, the taxpayer could add $2,000 of ordinary income before seeing an increase in the effective tax rate on the next $500 of income.

Read more about the Solve for Max feature here.

Range Calc takes that one step further and illustrates what happens beyond that next change in the effective rate, as well as provides attribution for the various taxes and phase-ins/outs that make up the total tax rate.

Below is an example of what a Range Calc graph will look like. Recall that the first increase in the effective rate (total tax / taxable income) occurs at $2,000 of additional ordinary income. This is when the taxpayer starts being subject to NIIT.

However, the client will remain in the 22% marginal bracket with up to $54,000 of additional ordinary income.

Modeling Roth Conversions in Scenario Analysis

Use Scenario Analysis to model a Roth conversion and determine the optimal conversion amount to fill a tax bracket, avoid an IRMAA surcharge increase, or take into account other tax considerations.