Roth Conversions: Good Idea?

by | Jul 26, 2022

Roth conversions are the repositioning of assets in a Traditional IRA or qualified employer sponsored retirement plan to a Roth IRA. This strategy could make sense for investors even as they approach retirement, but it’s important to understand the implications that may arise.

We know that taxes are one of life’s two inevitables. So, the question is not if you will pay taxes on your retirement accounts, but when and how much. That’s where Roth IRAs enter the discussion, especially in the current tax and market environment.

With a traditional IRA, pre-tax dollar contributions grow tax-deferred. The benefit for most people is that after you retire and start taking money out of your IRA, you may be in a lower tax bracket.

A Roth IRA, on the other hand, is funded with after-tax dollars, meaning you’ve already paid income tax on your contributions, so your withdrawals after 59½ are tax-free (if the account has been open for at least five calendar years).

It’s important to know this distinction when setting up an IRA and make the proper choice for the long term. Most investors, however, have had more limited access to Roth 401(k)s or have been limited by the max contribution limit for Roth IRAs. Also, all employer match contributions and employer profit sharing contributions that take place in an employer sponsored retirement plan are deposited into a pre-tax bucket. Therefore, the vast majority of retirement assets that I’ve seen have been in pre-tax IRAs or 401(k) accounts.

But the federal government did investors a favor in 2010 and began allowing conversions from traditional to Roth IRAs, without income limits. The conversion to a Roth can be from a traditional IRA, simplified employee pension (SEP) IRA, or savings incentive match for employees (SIMPLE) IRA.

Remember, this article is for informational purposes only, not a replacement for real-life advice. A professional should be consulted before attempting this type of strategy. Tax rules are constantly changing, and there is no guarantee that the tax treatment of Roth or Traditional IRAs will remain the same as it is now.

Also, Roth conversions have come under much scrutiny during the past few years. Congress has considered legislation that would prevent high-income Americans from Roth conversions. While no action has taken place, it is possible that Roth rules may change in the future.


Benefits of Converting to a Roth

Converting your traditional IRA to a Roth may make sense if you anticipate that tax rates will increase in the future or that your personal circumstances could put you in a higher tax bracket upon retirement because Roth withdrawals are tax-free.

Moving to a Roth IRA also means that you won’t have to take required minimum distributions (RMDs) on your account when you reach age 73. Under current IRS rules, if you are the original owner of a Roth IRA, you never have to make mandatory withdrawals from your account. This is important for estate purposes since it may leave more money in your account, growing tax-free, to pass on to your heirs.

Keep in mind that under the 2019 SECURE Act, most non-spouse beneficiaries of a Roth IRA are required to have the funds distributed to them by the end of the tenth calendar year following the year of the original owner’s death.


Downside of a Roth Conversion

The downside is the money moved to a Roth is taxable when it’s converted. The converted amount shows up as income on that year’s tax return. That extra reported income could have consequences for your tax bracket or even the cost of your Medicare premiums or other health insurance coverage (through for those not yet on Medicare). Many investors adopt a partial conversion strategy, to keep the reportable income smaller.

Also, if you’re close to retirement, it may not make sense to convert as gross income is usually higher in the final years before retirement. However, given the dynamics of your situation, sometimes a Roth conversion in the late stages of your working career could still make sense.


Paying the Taxes

The effectiveness and advisability of a Roth conversion depend on your funding sources for paying the up-front taxes. If you don’t have the savings available elsewhere to pay the taxes, a conversion may not make sense. Taking out a loan to pay the taxes may not be the best move in a rising-rate environment. And using money from the retirement investment you are converting will mean you forfeit the potential growth of those assets for years to come.


What To Do?

Choosing to convert to a Roth is not a simple decision. But, when markets are down, it can present an even more attractive opportunity to take advantage of a Roth conversion.

Reach out to a trusted financial professional who can help you weigh the pros and cons of a move like this and give you guidance to ensure any decisions are consistent with your long-term financial goals.

Want more help? Let’s chat.

Joe Allaria, CFP®

Joe Allaria, CFP®

Wealth Advisor | Partner

As featured in The Wall Street Journal,,,, and Yahoo Finance.

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