Should You Convert Your IRA to a Roth?

If you’ve spent any time reading about retirement planning, you’ve probably heard someone say you should consider a Roth conversion, but should you really? Like most tax questions, the answer is: it depends.

A Roth conversion can be a valuable retirement planning tool, but it isn’t automatically the right move for everyone. More importantly, deciding whether to convert isn’t just about looking at your retirement account balance. You have to consider your income, taxes, future required distributions, other investments, and what you’re ultimately trying to accomplish with your money.

Here’s what you need to know.

What Is a Roth Conversion?

A Roth conversion is exactly what it sounds like. You move money from a pre-tax retirement account, such as a traditional IRA, into a Roth IRA.

With a traditional IRA, you generally receive the tax benefit upfront. Your money grows tax-deferred, and you pay income tax when you take taxable distributions later. A Roth IRA works differently. Qualified withdrawals in retirement are tax-free, but you don’t receive a deduction for Roth contributions when the money goes in.

When you convert pre-tax retirement dollars to a Roth, you’re essentially choosing to pay the applicable income tax now in exchange for the potential benefit of tax-free qualified withdrawals later, and that “pay the tax now” part is important.

A Roth Conversion Can Increase Your Taxable Income

The taxable portion of a Roth conversion is generally included in your income for the year the conversion takes place. If you convert $50,000 of pre-tax IRA funds, for example, that could mean adding $50,000 to your taxable income for the year. That doesn’t necessarily make the conversion a bad idea, but it does mean we need to look at the bigger picture before moving money.

A large conversion could push some of your income into a higher tax bracket or have other consequences tied to your income. That’s why we usually don’t want to make a Roth conversion decision based on the retirement account alone.

When Can a Roth Conversion Make Sense?

One opportunity can come during a year when your taxable income is lower than usual. Maybe you’ve retired but haven’t started Social Security yet. Maybe your business income is temporarily down. Or maybe you have a window of several years between retirement and the point when required minimum distributions begin. Those lower-income years can sometimes give us an opportunity to intentionally recognize additional taxable income at a potentially lower tax rate.

A conversion can also be part of a longer-term strategy for managing required minimum distributions. Traditional retirement accounts are generally subject to RMD rules once you reach the applicable age. Roth IRAs, on the other hand, do not require distributions during the original owner's lifetime under current federal rules. Converting some traditional retirement money ahead of time may reduce the balance that will eventually be used to calculate future RMDs.

But again, that doesn’t mean everyone approaching RMD age should immediately start converting.

Bigger Isn’t Always Better

One of the biggest mistakes you can make with a Roth conversion is assuming that if converting some money is good, converting all of it must be better.

Sometimes a partial conversion makes more sense.

Instead of creating one enormous taxable event, we may look at converting smaller amounts over several tax years. That gives us more control over how much taxable income we recognize each year and can help us work within your larger tax strategy.

The right amount depends on your individual numbers.

This is where tax planning and investment planning really need to talk to each other.

It’s About More Than This Year’s Tax Bill

The real question isn’t simply, “How much tax will I owe if I convert?” We also want to ask what your taxes could look like five, ten, or twenty years from now. What other retirement income will you have? When will you claim Social Security? What could your RMDs look like? How are your investments structured? Are there assets you hope to leave to your family?

There’s no single calculation that makes a Roth conversion right for everyone.

The goal is to look at your entire financial picture and determine whether paying some tax today could put you in a better position tomorrow.

Don't Wait Until the End of the Year

Roth conversions are one of those strategies that benefit from planning ahead.

If you’re considering a conversion, talk to us before you move the money. We can look at your projected income, current tax situation, retirement accounts, and long-term goals to help determine whether a conversion makes sense and, if it does, how much you may want to consider converting.

At Personal Financial Services, we want retirement planning to be proactive, not something that starts when a tax form arrives.

If a Roth conversion has been on your mind, reach out to our team. We can help you look at the numbers before you make the move.