Is It a Good Idea to Convert a Traditional IRA to a Roth IRA?

Converting a traditional IRA (Individual Retirement Account) to a Roth IRA is a great move if you can swing it, says an article from U.S. News & World Report, “How to Convert to a Roth IRA.” The advantages to the account owner and heirs are considerable.

The Roth IRA grows tax-free, which is good for trimming taxes during retirement when income is usually limited. It is only available to single tax filers earning less than $146,000, or $230,000 for people filing jointly. However, higher earners can use the Roth conversion to fund a Roth from a traditional IRA.

Financial advisors say people still working should make the conversion if they are in lower tax brackets than they will be during retirement.

A good time for the conversion is after you’ve retired and before you’re required to take RMDs (Required Minimum Distributions) from the traditional IRA. The goal is to save lifetime taxes. How does it work?

When transferring funds from a traditional IRA to a Roth IRA, the account owner must pay taxes on the amount being transferred at their current income tax rate. However, once the conversion is made, those funds grow tax-free. Even better, when you take out qualified withdrawals in retirement, the withdrawals are tax-free.

Roth conversions are a good idea for people in lower income brackets with retirement savings in IRAs. People who might be taking unpaid leave or are unemployed may also benefit from lowered income levels.

The key benefit of a Roth conversion is reducing taxes. Contributions are made with after-tax dollars, which means account owners don’t receive any income tax deduction upfront, which is what happens with a traditional IRA. However, once you start taking withdrawals from a Roth, as long as you’re 59 ½ or older and the account has been open for at least five years, you’ll enjoy not paying taxes on those withdrawals.

There is more to appreciate about a Roth IRA. There are no Required Minimum Distributions, so you can take or not take withdrawals whenever it suits your budget. As your estate planning attorney will tell you, your heirs will not pay income taxes on withdrawals or distributions either.

Then there’s the “Backdoor Roth,” where high-income taxpayers may contribute to Roth IRAs even though their income is higher than the allowable amount. This is a little intricate, and you may want to speak with your financial advisor or estate planning attorney about it. You make a nondeductible contribution to a traditional IRA, then convert it to a Roth IRA. This should coincide with any other retirement and estate planning strategies.

There are some pitfalls. You’ll need cash to pay taxes on the conversion. If you’ve done the conversion when your income tax rates are high, it may not make sense. Do this when you’re in a lower-income tax bracket.

Last thought – if you plan to pay the taxes out of the account you’re converting, the conversion will be less valuable, as the funds to pay the taxes won’t be converted and enjoy years of tax-free growth.

Reference: U.S. News & World Report (July 19, 2024) “How to Convert to a Roth IRA”