Join Lena McQuillen, CFP®, Vice President and Director of Financial Planning, in an exploration of how Roth IRA conversations can lower your lifetime tax burden and maximize retirement flexibility.

 

With the expiration of the Tax Cuts and Jobs Act looming in 2025, many are considering Roth conversions as a savvy move to lock in today’s low rates and secure tax-free income in retirement. This strategy not only offers tax-free growth and future tax-free withdrawals, but also eliminates required minimum distributions (RMDs) in retirement. For those looking to reduce their lifetime tax burden and gain more control over their retirement income, Roth conversions can be an appealing solution.

What is a Roth Conversion and How Does it Work?

Traditional IRAs are funded with pre-tax dollars, allowing tax deductions on contributions, while Roth IRAs are funded with after-tax dollars. Both offer the long-term benefit of tax-free growth, but qualified withdrawals from a Roth IRA—including earnings—are tax-free (as long as certain conditions are met).

A Roth conversion involves moving funds from your pre-tax retirement account, such as a Traditional IRA, into a Roth IRA. Though you must pay taxes on the amount converted, the long-term benefit of tax-free growth and withdrawals often outweighs this drawback. Additionally, Roth IRAs do not require RMDs during your lifetime, so your account can continue growing tax-free for as long as you let it. You can convert all or part of your retirement account, allowing you to tailor a strategy based on your current tax situation and long-term financial goals.

What Should You Weigh Before Converting?

Before deciding to convert, it’s important to compare your current tax rate to your expected tax rate in retirement. Many people assume they’ll be in a lower tax bracket during retirement, but that’s not always true. As pre-tax retirement accounts grow, future RMDs—which are taxed as ordinary income—can push you into a higher bracket. Other income sources like Social Security, investment income, and capital gains can further elevate your tax rate.

Also, it’s crucial to ensure you have cash available to cover the taxes owed, as the IRS requires you to pay taxes on the converted amount in the year of conversion. Avoid using IRA funds to pay this tax, as this would unnecessarily increase your taxable income and reduce the benefits of the conversion. Instead, consider using cash or assets from a taxable account to cover the tax bill, if it doesn’t lead to a much larger capital gains tax.

Who Might Benefit from a Roth Conversion?

Roth conversions are especially beneficial for retirees in the transition window between stopping work and the start of RMDs. This period often sees a drop in income, making it an ideal time for conversions at a lower tax rate.

If you’re still working and anticipate higher future earnings or are in the early stages of your career, you may also benefit from a Roth conversion. Converting your Traditional IRA or employer-sponsored plan while in a lower tax bracket allows you to take advantage of today’s lower rates, maximizing tax-free growth and withdrawals in retirement.

Additionally, consider a Roth conversion during years with significant deductions or tax credits to help offset the income generated by the conversion. Although capital losses can’t offset Roth conversion income, strategically choosing favorable tax years (with lower income) can reduce the immediate tax impact while still allowing for long-term tax-free growth.

Who Should Avoid Roth Conversions?

Roth conversions aren’t for everyone. If you’re nearing or in retirement and plan to use IRA funds for living expenses soon, converting those funds may not make sense. Conversions need time to grow and offset the tax bill.

If charitable giving is a part of your financial plan, keeping your assets in a Traditional IRA may be wiser. Donating directly from a Traditional IRA through a Qualified Charitable Distribution (QCD) satisfies RMD requirements without creating taxable income. Leaving a Traditional IRA to a qualified charity at death allows them to receive the full value tax-free. Converting funds results in unnecessary taxes.

For individuals relying on financial aid or income-based benefits, the increased taxable income from a Roth conversion could affect your eligibility. And for those subject to mandatory RMDs—currently starting at age 73—Roth conversions are not practical as you’d pay taxes on both the RMD and the amount converted, potentially adding an extra tax burden.

Finally, if you’re uncomfortable paying the upfront taxes, a Roth conversion may not be right for you.

Looking Beyond the Immediate Tax Impact

For decades, you’ve been encouraged to save in pre-tax accounts like Traditional IRAs. While this strategy is sound, especially in peak earning years, these accounts grow tax-deferred and can result in significant balances by retirement, particularly when RMDs begin.
Many people focus on the immediate tax hit of a Roth conversion, but it’s essential to take a long-term view. Not only will converted funds grow tax-free, but so will their earnings, leading to potentially significant savings over time.

A key benefit of this strategy is tax diversification. Having a mix of Traditional IRAs, Roth IRAs, and taxable accounts provides flexibility in managing your taxes during retirement. While RMDs from Traditional IRAs are taxed as ordinary income, Roth IRAs allow tax-free withdrawals. This diversification gives you more control over your tax exposure and can help you minimize taxes in retirement.

Ultimately, while a Roth conversion might increase your taxes in the year of conversion, it can reduce your overall tax burden over your lifetime. A well-timed, strategic conversion can help manage the taxation of your retirement income and potentially lower your total tax bill in retirement. The goal is to create a balance between taxable and tax-free accounts, providing more control and flexibility over your finances.

Conversion Strategy

A smart approach to Roth conversions is to consider partial or staged conversions over several years. This strategy lets you convert smaller amounts each year based on your tax bracket, helping you avoid moving into a higher tax bracket. By converting just enough each year, you can minimize the immediate tax impact while still reaping the long-term benefits of a Roth IRA.

Is a Roth Conversion Right for You?

Considering a Roth conversion is a significant decision. Work closely with your tax professional and investment counselor to evaluate your situation. Keep in mind that a conversion may impact your adjusted gross income (AGI), potentially reducing deductions or triggering Medicare surcharges. However, don’t shy away from the conversion due to these short-term impacts. The tax hike and loss of benefits will only affect you for one year, while the benefits of a Roth IRA—growing tax-free for decades—can far outweigh the temporary drawbacks. By carefully planning and understanding the long-term implications, you can make a Roth conversion a cornerstone of a more tax-efficient retirement.

Planning Ahead: Maximizing Your 401(k) Strategy

In addition to considering a Roth conversion of your Traditional IRA, it’s essential to think about your retirement savings strategy moving forward. In a future article, we’ll dive into whether contributing to a Traditional 401(k) or a Roth 401(k) makes the most sense. With numerous recent changes made to retirement plans introduced by the SECURE Act, we’ll explore which strategy aligns best with your family’s financial goals. Stay tuned as we explore how these factors could shape your retirement savings strategy.