If you've been hearing more about Roth conversions lately, you're not alone. As tax rates remain a moving target and retirement planning grows more complex, more people are asking whether converting some or all of their traditional IRA or 401(k) to a Roth makes sense. Here's what you need to know.
What Is a Roth Conversion?
A Roth conversion is the process of moving money from a pre-tax retirement account, like a traditional IRA or 401(k), into a Roth IRA. When you do this, you pay income taxes on the amount converted in the year of the conversion. In exchange, that money grows tax-free and qualified withdrawals in retirement are not taxed.
Unlike a Roth contribution, there are no income limits on who can do a Roth conversion. Anyone with a pre-tax retirement account can do one, though how much you convert, and when, matters a great deal.
When Might a Roth Conversion Make Sense?
Timing is everything with Roth conversions. Here are some common scenarios where a conversion may be worth considering:
· You're in a lower-income year. If your income is temporarily reduced due to a career transition, early retirement, or a business slowdown then you may be in a lower tax bracket than you expect to be in the future. That gap is an opportunity.
· The market has pulled back. Converting during a market downturn means you're moving a lower account value, and paying taxes on less, while still capturing the full recovery inside your Roth.
· You're earlier in your career or retirement journey. The more time that money has to grow tax-free, the more valuable the conversion becomes.
· You believe tax rates will be higher in the future. Whether due to policy changes or your own income growth, paying taxes now at a lower rate can be a smart long-term move.
Why Consider Doing a Conversion?
The biggest benefit is tax diversification. Having both pre-tax and after-tax retirement accounts gives you flexibility in retirement to manage your income, and your tax bill, more strategically.
There's also an estate planning angle. Roth IRAs are not subject to Required Minimum Distributions (RMDs) during your lifetime, which means more of your assets stay invested and growing. And when passed to beneficiaries, Roth accounts can continue to provide tax-free income.
Roth Conversions and Medicare
One often-overlooked consideration: Roth conversions increase your taxable income in the year you convert. If you're on Medicare or approaching it, a large conversion could trigger Income-Related Monthly Adjustment Amounts (IRMAA) surcharges added to your Medicare Part B and Part D premiums.
This means you need to plan carefully around how much you convert in any given year and understand the income thresholds involved.
A Word of Caution
Roth conversions aren't right for everyone. Before moving forward, make sure you've considered:
· Your current tax bracket and how a conversion would affect it
· Whether you have funds outside the retirement account to pay the tax bill (using retirement funds to pay the tax defeats the purpose)
· Your state's tax treatment of Roth conversions
· Your Social Security income and whether a conversion could increase the taxable portion
· IRMAA thresholds if you're on or near Medicare
· Your overall retirement income plan and projected tax rates in retirement
Is a Roth Conversion Right for You?
The answer depends on your full financial picture. It depends on your income today, what you expect in retirement, your estate goals, and your tax situation. There's no universal right or wrong answer, but there are better and worse times to act.
If you're curious whether a Roth conversion should be part of your strategy, we're happy to walk through the numbers with you. Contact a member of the SKG Team today!