Few planning strategies get as much attention as the Roth conversion, and for good reason. Done well, it can save a meaningful amount of tax over your lifetime. Done at the wrong time, or in the wrong amount, it can create costs you didn't see coming. With year-end approaching, now may be a good moment to think it through.
What is a Roth Conversion?
A Roth conversion moves money from a pre-tax account, like a Traditional IRA, into a Roth IRA. You pay income tax on the amount you convert in the year of conversion. In return, that money can grow, and be withdrawn in retirement, tax-free, as long as the rules are met.
Why You May Want to Convert
- Tax-free growth. Qualified withdrawals in retirement aren't taxed.
- No required withdrawals. Roth IRAs have no required minimum distributions during your lifetime.
- More flexibility. Holding both pre-tax and Roth dollars gives you more control over your tax bracket each year.
- A tax-smart legacy. Heirs generally inherit Roth money income-tax-free.
What to Weigh Before Converting
- Cash for the tax bill. The tax is due because of the conversion, so it helps to have the cash ready. Paying it from savings outside the IRA is usually best. Using IRA dollars shrinks what's left to grow tax-free, and if you're under 59½, withholding may trigger a 10% penalty.
- Your tax bracket. A conversion stacks on top of your other income. Converting smaller amounts over several years may keep you from jumping into a higher bracket.
- Medicare premiums (IRMAA). Higher income can add a surcharge to your Medicare premiums two years later, and Roth conversions increase income. Crossing a threshold by even $1 counts.
- Other ripple effects. More income can cause more of your Social Security benefits to be taxable and reduce certain credits or deductions.
- It can't be undone. Once money is converted, the decision is final.
When is the Right Time to Convert?
Lower-income years are often the best windows, such as early retirement before Social Security and required distributions begin. And because a conversion must be completed by December 31 to count for this tax year, the coming weeks are the time to decide if converting this year makes sense for you.
Does a Roth Conversion Make Sense for You?
There's no one-size-fits-all answer. The right amount and the right year depend on your income, your goals, and the cash you have on hand. If you'd like to see what a conversion could look like in your own plan, we'd be glad to run the numbers together with your tax professional.
Traditional IRA account owners have considerations to make before performing a Roth IRA conversion. These primarily include income tax consequences on the converted amount in the year of conversion, withdrawal limitations from a Roth IRA, and income limitations for future contributions to a Roth IRA. In addition, if you are required to take a required minimum distribution (RMD) in the year you convert, you must do so before converting to a Roth IRA.