To do a Roth conversion or not to do a Roth conversion, that is the question. 

A Roth conversion presents a strategic avenue for high-earners to take advantage of a Roth IRA while not contributing directly. 

While Roth conversions grant increased access to this coveted account, there are several factors to consider before initiating a conversion. Let’s take a look at five telltale signs a conversion may or may not be a good move for you.  

The Difference Between Roth and Traditional Accounts

Before you start moving money around, it’s essential to understand the difference between Roth and traditional accounts. 

The primary difference comes down to one defining factor: taxes.

In traditional accounts, like 401(k)s, traditional IRAs, 403(b)s, etc., you generally contribute with pre-tax dollars and pay taxes when you take the money out. Keep in mind that you may not be able to make deductible (pre-tax) contributions to a traditional IRA for those earning above a certain modified adjusted gross income and covered by workplace retirement plans.  

With Roth accounts, like Roth IRAs and Roth 401(k)s, it’s the opposite. You fund the account with after-tax dollars, and the tax benefit comes later when you withdraw the funds tax-free. 

The timing of when you pay taxes on your retirement dollars can make a significant difference in the longevity of your investments. Tax-free money in retirement provides more freedom and flexibility in terms of your retirement spending plan. It also doesn’t increase your taxable income, stretching your retirement dollars further.

What’s A Roth Conversion?

A Roth conversion allows you to convert funds from a traditional IRA to a Roth IRA.

Conversions are excellent strategies for high-earners whose modified adjusted gross incomes exceed the limit to fund Roth IRAs directly. In 2021, you can no longer put money into a Roth if you earn $140,000 for single filers and $208,000 if married filing jointly. 

While you have to pay taxes on the amount you convert, you won’t have to worry about taxes upon withdrawal in retirement.

Learn more about Roth conversion considerations from the chart below.

Should you do a Roth Conversion?

Now you know the basics. So, is a Roth conversion the right move for you?

Sign #1: You Think Tax Rates Will Be Higher in The Future

When it comes to retirement accounts, we know that distributions will be taxed at the current national and state rates.

Tax rates are unpredictable and constantly in flux. Although we know what the tax rates are now, no one can be certain of the tax rate when you decide to withdraw from your retirement accounts (what an ultimate magic power that would be). 

Many economists also believe that rising national deficits and inflation could result in higher taxes in the future. If you want to take advantage of the current tax rate before it may increase, a Roth conversion could be a solid option to consider.

Sign #2: You Anticipate Being In A Higher Tax-Bracket In Retirement 

While no one can foretell what the exact tax rates will be when you retire, you can have a good idea about your income growth over the life of your career.

If you anticipate being in a higher tax bracket in the future, it may make sense to prioritize a conversion today as you’ll pay taxes at a lower rate now than you would in retirement. When considering a Roth conversion, you must ask yourself financial questions about where you will really be financially in the future.

 Do you believe you will earn more in your retirement than you do right now?

 If so, paying taxes at your current rate is preferable to paying a higher rate after you’ve stopped working. Additionally, while you make less and are at a lower rate, paying taxes on that money now will serve you in retirement.

Many people expect their expenses and earnings to decrease throughout their golden years, but that’s not always the case. Often people on the brink of retirement are at their peak earning years, and therefore, fall into higher income tax brackets. 

Sign #3: You Want to Pass Money To Your Heirs Securely

Roth IRAs are an excellent estate planning tool. 

Unlike traditional retirement accounts, Roth IRAs don’t have required minimum distributions meaning you have more control over what you do with the funds. You don’t have to take any distributions in retirement if you don’t want or need to. You can dedicate all or a portion of your Roth IRA to your estate and legacy plan.

What’s more is that you can hang onto the account your entire life, enjoy tax-free earnings, and pass the account to your heirs tax-free. 

Sign #4: You Had a Low-Income Year

Low-income years may not be your favorite, but they can come with critical financial opportunities. If you made less money than typical, it might be the perfect time to convert funds to a Roth IRA.

With a lower adjusted gross income, you’ll end up paying taxes in a lower tax bracket than you’re used to. This move optimizes your long-term tax outlook. Be sure to structure the conversion, so it doesn’t tip you into the next tax bracket. Work with your financial planner and tax professional to structure a conversion that works for you.  

Sign #5: You Aren’t in Any of These Situations

So Roth conversions are unique opportunities, but they aren’t suitable for every person at all times. There are a few situations where it likely wouldn’t make sense for a conversion. Let’s take a look. 

  • You need income from your traditional IRAs shortly. Whether you are in or are approaching retirement, if you need to take a sizeable distribution from your traditional IRA, a conversion wouldn’t make much sense since you wouldn’t have time to recoup the upfront tax expense.
  • You’re in retirement, and the conversion would bump you into a higher tax bracket. Roth conversions can have a domino effect for retirees, especially if you’re enrolled in Medicare and Social Security. A Roth conversion increases your taxable income, and if you increase it too much, you could also increase your Medicare Part B and Part D premiums (IRMMA) and the taxable portion of your Social Security benefits. 
  • You plan on donating funds from your traditional IRA. Qualified charitable distributions (QCDs) allow retirees to donate funds tax-free from a traditional IRA to a qualified charitable organization. If you plan to do this, it doesn’t make sense to take funds away from the account. 

Roth Conversions Are Complex, Turn To The Pros

A Roth conversion can present meaningful opportunities for long-term financial growth. But they aren’t right for every person in every situation. We’re here to help you determine if this move could enhance your plan.

Need help figuring out if a Roth conversion makes sense for you or need help with tax planning? Set up a time to talk with us today. 

And, remember above all, to thine own self (and your goals and values) be true.


The contents of this article are for general information and educational purposes and should not be construed as specific investment, financial planning, tax, accounting, or legal advice. Please consult with a professional advisor before taking any action based on the contents of this article. All investment and financial planning strategies involve the risk of loss that you should be prepared to bear. We cannot guarantee any investment performance whatsoever, and past performance is not indicative of potential future returns.