Broker Check
Should you consider a Roth Conversion?

Should you consider a Roth Conversion?

July 07, 2023

It’s very common that families approaching retirement have been saving in Traditional 401(k)’s, IRA’s or an equivalent company sponsored retirement plan during their working years.  It’s been a huge benefit to save money on a pre-tax basis to reduce your tax bill each year.  Now, as you approach retirement you may be worried about taxation of your Social Security, Retirement Income/Required Minimum Distributions and Medicare Surcharges. One way to potentially reduce this tax burden is to convert a Traditional IRA to a Roth IRA.

Here’s how Roth conversions work:

Your assets are transferred from your Traditional IRA to a new Roth IRA directly.  This triggers a taxable event.  Since Traditional IRA assets have been tax-deferred, taxes are due at the time of conversion either by direct withholding from the Traditional IRA or by using taxable investments and/or cash to pay the tax.

Here are the benefits:

  • No required minimum distribution- You control when and how much to withdraw funds.
  • Tax-free growth- All investments in the account grow free from taxation.
  • Tax-free withdrawals- After age 59.5, you generally tap the account without tax or penalty.  Contributions can be withdrawn at any time.  If you don’t have a Roth IRA already, you must wait 5 years before taking out the earnings.
  • Social Security and Medicare flexibility- Doing a Roth IRA conversion before claiming Social Security and Medicare is beneficial, because future distributions from Roth IRA’s won’t impact the tax implications of Social Security and Medicare surcharges.
  • Variety of accounts- Having multiple buckets to withdraw from provides additional tax planning benefits for you.
  • Tax-efficiency for beneficiaries- Your beneficiaries are required to withdraw the funds within 10 years. Making those withdrawals tax-free is a significant benefit to them.
  • Early retirement- Roth IRA contributions can be accessed tax-free and penalty free prior to age 59.5.  Converting from Traditional IRA’s to Roth IRA’s prior to age 59.5 avoids the 10% early withdrawal penalty.  If you do not have an existing Roth IRA, earnings cannot be spent for 5 years or age 59.5, whichever happens later. 

Here are some considerations:

  • Conversion taxes should be paid from an outside taxable investment account or cash to be most effective. 
  • A market pullback is often the best time to make a conversion since reduced capital gains (on the taxable investment account) means a lighter tax bill. 
  • A market pullback also means you can reduce the tax bill on the Traditional IRA to Roth IRA conversion.
  • The conversion amount could push you into a higher tax bracket for the year.  You should consider doing some Tax Planning to determine an amount to convert and consider doing the transition over time.
  • Your breakeven point is typically at least 10 years depending on your tax rate, so deferring withdrawals helps maximize the benefits.
  • Breakeven point is not a consideration for early retirement as the strategy is designed to avoid the 10% early withdrawal penalty.  Only the amount needed for income in each given year should be converted to avoid being pushed into a higher tax bracket.

Whether this is the right or wrong move for you depends on your needs, time horizon and circumstances.  Whether you're doing Tax Planning or Retirement Income Planning, our team can help you determine the best strategy for you.