When Do Roth Conversions Make Sense?
The question comes up most often from clients in their late fifties and sixties, a few years from retiring. Should I convert my traditional IRA to a Roth? They've read a headline or talked to a friend, and they want a straight yes or no.
A Roth conversion moves money from a traditional IRA or 401(k) into a Roth IRA, paying ordinary income tax on the amount now in exchange for tax-free growth and withdrawals later. The real answer on whether to do one is more nuanced than a headline can capture, depending on a number of factors and, especially, timing. Here's how I think through the decision with clients.
Who Benefits From a Roth Conversion
In each case below, the goal is the same: rate-smoothing, paying tax on some of the balance now, at a known rate, instead of leaving all of it to be taxed later at whatever rate you end up in.
Recent Retirees Who Maxed Out Pretax Contributions for Decades
Deferring taxes on decades of contributions was a reasonable choice, and for anyone who started before 2006, often the only one, since Roth 401(k)s didn't exist yet. But a large balance that's never been touched eventually meets required minimum distributions (RMDs) big enough to push the owner into a bracket higher than any they saw while working.
The years right after leaving full-time work, before RMDs and Social Security start, are the window to convert. Working straight through into your 70s shrinks or closes that window, since RMDs must start by age 75, depending on birth year. A Roth balance has no RMDs at all, so once it's converted, the money stays out of that forced-withdrawal schedule entirely.
People In a Low-Income Year
This could be someone taking a career break, a contractor, or a commission-based earner having a slow year, provided there are funds on hand to pay the conversion tax bill. A low-income year can be a rare chance to Roth convert at a relatively low tax rate.
People Concerned With the Taxes Their Heirs Will Pay
Non-spouse beneficiaries now have to empty an inherited IRA within ten years, often during a working adult child's highest-earning years. A Roth IRA passes to them tax-free instead.
The Downsides of Roth Conversions
The basic downside is straightforward: converting means adding to your taxable income and paying more tax now, in exchange for a benefit that shows up later. You need to be prepared for that bill and able to cover it efficiently, or the tradeoff stops making sense.
How you come up with the cash matters. If covering the tax bill means selling investments with meaningful capital gains, or pulling extra money out of the IRA itself, either move creates more taxable income on top of the conversion, and the total cost can end up higher than expected.
The ACA subsidy cliff affects anyone bridging to Medicare on ACA marketplace health insurance. A large conversion can push taxable income past the threshold for premium tax credits and erase a subsidy worth thousands of dollars.
A related cost applies to anyone already on Medicare. IRMAA, the income-based surcharge on Part B and Part D, is based on your tax return from two years earlier.
None of this rules out converting. These costs need to be weighed alongside the benefits before deciding whether a Roth conversion makes sense.
Roth Conversions May Take Years to Implement, With Annual Adjustments
Once someone has decided Roth conversions will be a net benefit, it then needs to be decided how much to convert and over how many years. Converting everything in one year tends to push income through several brackets at once. Converting in pieces, filling up one bracket at a time, is often more tax efficient, and how long that takes depends on the situation.
Someone in a low-income year might convert for just a few years or even less. Someone with a large pretax balance and no natural low-income year might convert smaller amounts for a decade or more instead. What matters most is the top of the bracket you're trying to stay under, and how much room is left in it once everything else is accounted for. That number is hard to know precisely in January and much clearer by November.
State and local income tax applies on top of federal. Maryland, DC, and Virginia all tax Roth conversions as ordinary income. Planning to relocate to a lower-tax or no-tax state in the next few years is often a reason to hold off converting until after the move, while moving into the DC area from a lower-tax state can make converting before the move the better call.
Where Roth Conversions Fit in Your Broader Plan
A Roth conversion only makes sense next to everything else in a plan: current income, expected retirement income, Social Security timing, healthcare coverage, and what happens to the account after you're gone. Once converted, the balance also becomes a tool for that ongoing plan: a Roth withdrawal doesn't add to your taxable income, which gives you a lever to pull in later years when you're trying to stay under a bracket threshold or avoid an IRMAA surcharge. The sizing isn't a one-time decision either. The number that makes sense this year depends on where things stand this year, which means it's worth revisiting annually rather than setting once and leaving alone, whether that's something you track yourself or as part of ongoing work with an advisor.
For clients, this comes out of the same projection work behind retirement income planning and ongoing tax planning.
If you're approaching retirement and considering Roth conversions, I'd welcome a conversation. You can schedule a free introductory call.
FAQ
Is there an income limit on Roth conversions?
No. Roth IRA contributions phase out at higher incomes, but Roth conversions don't.
Do you pay the income tax on a Roth conversion from the converted funds?
You can, but it rarely makes sense. Whether you pull extra from the IRA or sell taxable investments with meaningful gains, either one adds more taxable income on top of the conversion itself, and under 59 and a half an IRA withdrawal for this purpose can also trigger a 10 percent penalty. Paying from cash or relatively high basis brokerage assets avoids that.
Do Roth conversions affect my Medicare premiums?
Yes, they can. Conversions raise your income for that year, and Medicare bases IRMAA surcharges on your tax return from two years earlier, which is easy to miss.
Can I convert while I'm still working?
Yes, there's no requirement to be retired. Since employment usually means a higher tax bracket already, converting while working tends to make the most sense for people who are confident they'll land in an even higher bracket down the road, or who simply want a Roth balance building sooner rather than later.
Can I undo a Roth conversion?
No. Recharacterization used to allow this, but it was eliminated starting with the 2018 tax year. Once you convert, it's final.