Should You Do a Roth Conversion? 5 Things to Consider
Roth conversions have become increasingly popular as a tax planning strategy, especially for people approaching retirement. But just because it's popular doesn't mean it's right for everyone. Here's what you need to know.
What is a Roth Conversion?
A Roth conversion is when you move money from a traditional IRA or 401(k) (pre-tax) into a Roth IRA (after-tax). You'll pay income tax on the converted amount now, but once it's in the Roth, it grows tax-free and you can withdraw it tax-free in retirement.
Think of it as prepaying your taxes. You're betting that paying taxes at today's rates is better than paying taxes later at potentially higher rates.
1. Your Current vs. Future Tax Bracket
This is the most important consideration. A Roth conversion makes the most sense when you expect to be in a higher tax bracket in retirement than you are now.
Let's say you're currently in the 22% tax bracket. If you expect to be in the 24% or 32% bracket in retirement (maybe due to pension income, Social Security, or required minimum distributions), paying 22% now could save you money long-term.
On the flip side, if you're in the 32% bracket now but expect to be in the 22% bracket in retirement, a conversion might not make sense.
2. Can You Pay the Tax Bill Without Touching the Converted Funds?
Here's a critical rule: You should pay the conversion tax from a separate source (like a savings account or taxable investment account), not from the IRA itself.
If you convert $50,000 and are in the 24% bracket, you'll owe $12,000 in taxes. If you use IRA funds to pay that tax, you're effectively converting only $38,000—and if you're under 59½, that $12,000 withdrawal might trigger a 10% early withdrawal penalty.
Bottom line: Don't do a Roth conversion unless you have cash on hand to pay the taxes.
3. Timing Matters
The best time to do a Roth conversion is when your income is unusually low. Common scenarios include:
The year you retire (before Social Security and RMDs kick in)
A year when you have a business loss
Early in your career when your income is still relatively low
A market downturn (your account balance is lower, so there's less to convert and less tax to pay)
You can also do partial conversions over several years to stay within a lower tax bracket, rather than converting everything at once.
4. Impact on Medicare Premiums and Other Benefits
If you're near retirement age, be aware that a large conversion can temporarily spike your income, which might affect Medicare premiums (through IRMAA surcharges) or other income-based benefits.
Medicare premiums are based on your income from two years prior. So if you do a big conversion in 2025, it could increase your Medicare premiums in 2027.
5. Your Time Horizon
Roth conversions work best when you have time for the tax-free growth to compound. If you're going to need the money in the next few years, a conversion probably doesn't make sense because you won't benefit much from the tax-free growth.
Generally, you want at least 5-10 years before you'll need to tap the converted funds. This gives the account time to grow and makes paying the upfront tax worthwhile.
Other Benefits of Roth IRAs
Beyond the tax benefits, Roth IRAs offer other advantages:
No required minimum distributions (RMDs) during your lifetime
Tax-free inheritance for your heirs
Flexibility to withdraw contributions (not earnings) at any time without penalty
The Bottom Line
Roth conversions can be a powerful tax planning tool, but they're not a one-size-fits-all solution. The decision depends on your current tax situation, future expectations, and overall financial plan.
Thinking about a Roth conversion? Let's run the numbers together and see if it makes sense for your situation. I work with clients and their CPAs to coordinate tax-efficient strategies.
Disclaimer: This article is for educational purposes only and should not be considered tax or investment advice. Please consult with a qualified financial advisor and tax professional before making decisions about Roth conversions.
