Roth IRAs are a powerful way to save for retirement because they are funded with after-tax dollars, and if certain requirements are met, withdrawals in retirement are completely tax-free.
You can fund a Roth IRA in two ways:
- Making annual Roth contributions (subject to income and contribution limits)
- Converting assets from a Traditional IRA or other qualified retirement plan
Unlike Roth contributions, Roth conversions have no income or contribution limits, making them a great option for those higher earners that exceed income limits. But just because you can convert doesn’t always mean you should. Here’s what to consider before making the move.
Key Considerations:
Tax Brackets
Before converting, think about two important factors:
- Your current tax bracket
- Your expected tax bracket in retirement
If you believe your tax rate will be higher in the future, converting now could help you pay taxes at today’s lower rates. While a conversion increases your taxable income now, the funds can grow tax-free in a Roth IRA for years—and withdrawals in retirement won’t be taxed.
Time Horizons
How long do your assets have to grow? Time is a key factor in deciding whether a Roth conversion makes sense. Even if you expect to be in a lower tax bracket in retirement, the longer your assets can grow in the Roth, the more it may make sense to convert now and lock in tax-free growth.
Impacts to Adjusted Gross Income
Adjusted Gross Income (AGI) as calculated on Form 1040 is used to determine eligibility for many deductions and credits in a given tax year. Because Roth Conversion amounts are taxed as ordinary income in the year of conversion, the conversion amount will increase AGI possibly eliminating the eligibility for deductions and credits.
If you are a Medicare recipient, the increase in AGI could subject you to IRMAA (Income Related Monthly Adjust Amount). This is otherwise known as the Medicare surcharge.
Managing Pretax and After-Tax IRA Contributions
Another important question: How much should you convert? This depends on the tax consequences.
- If your IRA contains only pretax contributions, the entire conversion is taxable.
- If you have a mix of pretax and after-tax funds, the IRS requires you to convert proportionally—you can’t just pick the after-tax portion and convert it tax-free.
Example:
Bob has two IRAs totaling $100,000:
- $60,000 in pretax contributions
- $40,000 in after-tax contributions
Bob converts $10,000 to a Roth IRA.
- $6,000 (60%) is taxable income
- $4,000 (40%) is tax-free
This is a simplified example. Be sure to consult a tax advisor to ensure accurate calculations and to properly file IRS Form 8606, which tracks after-tax contributions.
Long-Term Benefits: Avoiding RMDs & Legacy Planning
One major benefit of a Roth conversion? No Required Minimum Distributions (RMDs) during your lifetime. Traditional IRAs require withdrawals starting at age 73 (in 2033 the age to start taking RMDs will increase to age 75), which could push you into a higher tax bracket. By converting to a Roth, you eliminate this requirement, giving your investments more time to grow tax-free.
Considering your heirs?
- Spouse beneficiaries can roll over the Roth IRA and avoid RMDs.
- Non-spouse beneficiaries must withdraw funds within 10 years, but the distributions remain tax-free as long as the account has been open for at least five years.
If leaving a tax-free legacy is important to you, a Roth conversion could be a great tool.
Important: Roth Conversions Are Permanent
Prior to 2018, you could undo a Roth conversion if circumstances changed. However, the Tax Cuts and Jobs Act eliminated this option. Once you convert, you cannot reverse the decision, and taxes are owed for that year.
This makes careful planning essential. If you're unsure, you might consider partial conversions over several years to manage tax liability.
Final Thoughts: Is a Roth Conversion Right for You?
Roth conversions can be a powerful tax strategy, but they’re not right for everyone. Before deciding, consider:
- Your current and future tax rates
- How long your assets have to grow
- The mix of pretax and after-tax contributions in your IRAs
- Whether avoiding RMDs and leaving tax-free assets to heirs is important to you
A Roth conversion should fit into your broader financial plan—working with a financial planner and tax advisor can help ensure it’s the right move for you.
This material is for general informational purposes and does not constitute tax or legal advice. Please consult a tax professional before making decisions regarding Roth conversions.