Diversification Beyond Asset Allocation: Account Types Matter

To convert or not to convert? That is the question. 

The next few months are a good time for clients to ask whether converting some of their pretax retirement assets to a Roth account makes sense, now that most people have a sense of what their total income for 2026 will be. It’s also a good time to educate them about how Roth conversions can affect other aspects of their financial plan, especially future required minimum distributions and what heirs will eventually inherit.

“For investors with larger traditional IRA or 401(k) balances, the most effective Roth conversion decisions come from projecting several years into the future,” said Heather Rivas, wealth advisor at River Wealth Advisors. “It also requires a discussion about whether choosing to pay additional taxes today will pay off in the future.” 

Another Kind of Diversification 

Most retirement investors are familiar with diversification across different asset classes, industries and geographic regions. Fewer are focused on tax diversification, Rivas said, which is where an advisor can shine. 

“Converting to a Roth reduces the balance that will eventually be subject to RMDs,” Rivas said. “That can help retirees avoid being forced to recognize more taxable income than they need in a given year. IRAs are also a very tax-inefficient way to pass money to heirs.”

Any converted assets are counted as income, of course, so converting enough to fill a lower tax bracket may be attractive. However, converting additional dollars could push income into a substantially higher bracket or trigger other costs. 

These dynamics make the period after a client retires but before they claim Social Security an opportune time to convert assets at comparatively low tax rates. Some additional considerations: 

• A large conversion can increase modified adjusted gross income, potentially triggering higher Medicare premiums and surcharges. 
• A conversion may be less attractive if a retiree lives in a relatively high-tax state today but expects to move to a lower-tax state later.

Triple Threat. Funding a Health Savings Account is another way to add tax diversification to the overall plan, said Kimberly Lankford, a longtime AARP contributor and current reporter for The Wall Street Journal Buy Side. The HSA complements other retirement accounts with its unique ability to pay for medical care on a tax-free basis, including Medicare premiums and out-of-pocket costs, she told Advisor Upside. Clients can even move money directly from a Roth or traditional IRA to their HSA through a one-time direct transfer called a qualified HSA funding distribution, though the amount is subject to the annual HSA contribution limit and other eligibility rules.