Roth conversions can be a powerful tax strategy, but they’re not right for everyone.
Here’s how to think about them.
Many retirement savers know that Roth IRAs offer the benefit of tax-free growth and tax-free withdrawals in retirement. Roth IRAs have become even more popular now that your kids have to cash out the IRA they inherit from you in 10 years, instead of stretching distributions out annual over their lifetime!
But there is a lot of confusion surrounding Roth IRAs, often leading high income earners or those that have saved well over the years to think they are too late, not eligible to take advantage or unsure how to decide if a Roth IRA should fit into their plan.
There are two ways to add money to a Roth IRA: through a contribution or from a conversion. A contribution involves adding money that has already been taxed, to a Roth IRA from a non-retirement account. Think bank account or brokerage account. This is subject to annual limitations and considers your income, since you are adding brand new money to your retirement bucket. The limits in 2025 are $7,000 or $8,000 if 50 and older for an IRA. $23,500 or $31,000 if 50 and older, or $34,750 if between the ages of 60-63.
A Roth conversion involves moving money from an existing retirement account that has not been taxed yet, like a traditional IRA or pretax 401k and moving it into a Roth IRA. (You can also convert after tax money in a 401k to Roth, but that is a topic for another day.) This path has no limit on amount or compensation. To provide an extreme example if you expect to make $1million this year in income, and you wanted to convert your entire $3 million IRA all at once into your Roth IRA, the IRS will allow you to. I am not suggesting this approach, just pointing out how much more this approach allows you to move the needle relative to an annual contribution. Keep in mind that when you convert pretax money to Roth, you will owe taxes on the amount as income. In many cases doing Roth conversions strategically over multiple years tends to work better.
When used thoughtfully, Roth conversions can reduce long-term taxes and improve financial flexibility in retirement. But done at the wrong time or in the wrong way they can create an unnecessary tax bill.
When Roth Conversions Make Sense
You expect to be in a higher tax bracket later
If you’re in a relatively low tax bracket today but expect your income or tax rates to rise in the future, converting some assets now can lock in today’s lower rates. One of the more surprising causes of this, is required distributions from 401k and IRAs in the future.
You have “gap years” before required distributions or Social Security
Many retirees have a window between retiring and age 73 (when required minimum distributions, or RMDs, begin) where taxable income is lower. These are ideal years to consider strategic conversions.
You want to reduce future RMDs
Converting some pre-tax assets reduces the size of your traditional IRA, which can shrink future RMDs lowering taxable income and potential Medicare surcharges later.
You want to leave tax-free assets to heirs
Roth IRAs are especially attractive for wealth transfer, since beneficiaries can take tax-free withdrawals unlike traditional IRA heirs, who must pay income tax on distributions.
You have non-portfolio funds to pay the conversion tax
Its’s important to consider how you plan to pay the tax bill. It’s typically most advantageous when you can pay the tax bill from cash savings rather than from the IRA itself, but it isn’t a requirement.
When Roth Conversions May Not Make Sense
You’d be pushed into a much higher tax bracket today
Conversions are taxable. So it is important to understand how increasing your income impacts other items like Medicare premiums, net investment income, capital gains, and how much of your social security is taxable to name a few. If converting triggers an increase in some of these areas it may reduce or outweigh the benefit.
You plan to use the funds soon
Roth conversions are most valuable when the money can stay in the account and grow tax-free for many years. If you plan to spend it soon, the tax cost today may outweigh the benefit.
You’d need to use IRA funds to pay the tax
Paying the tax from the converted IRA amount reduces the benefit of the strategy and may incur penalties if you’re under 59½.
