Is a Roth IRA Conversion Right for You?

Could you benefit from a tax evaluation to assess whether paying tax now in exchange for years of tax-free growth will create wealth? This article will help you determine whether a Roth conversion aligns with your financial plan.

A Roth IRA allows your principal and earnings to grow completely tax-free, because contributions are made to a Roth IRA after tax. Key benefits of a Roth IRA are that distributions are not mandatory during your lifetime, and distributions made after age 59 1/2 and in a few other circumstances (such as a first-time home purchase) are not taxable.

In comparison, contributions to a Traditional IRA are generally tax deductible, and the income and earnings in a traditional IRA are eventually subject to income tax at ordinary rates as distributions are received. When you turn age 73, you must begin taking distributions from the traditional IRA, based on your life expectancy.

Funding a Roth IRA may be done either through annual contributions of $7,000 ($8,000 if you are over age 50) in 2025, or by converting your traditional IRA to a Roth. For 2026, the Roth IRA contribution limit will be $7,500 ($8,600 for those age 50 and older). The conversion process includes paying tax on the value of the traditional IRA, since assets in the traditional IRA have not yet been taxed.

Are You a Good Candidate for a Roth IRA Conversion?

If you meet all of the following criteria, you may be a good candidate for a Roth IRA conversion:

• You have a long time horizon, and
• You expect to be in the same or a higher income tax bracket in retirement than you are in the year of the conversion, and
• You have non-IRA assets from which to pay the conversion taxes (allowing the tax amount to grow tax-free inside the Roth).

Alternatively, you may be a good candidate for a Roth IRA conversion if:

• You have high tax deductions relative to your income (perhaps because of retirement or temporary unemployment), and you are losing the full benefit of your deductions, or
• Your traditional IRA required minimum distributions (RMDs) exceed your expenses in retirement, and your heirs are not a charity (since a charity pays no income tax on an inherited IRA).

Paying the Conversion Tax

You will generate a tax liability in the year of the conversion, and estimated tax payments may be due for the quarter when the conversion occurs.

Key Factors to Consider Before Converting to a Roth IRA

Questions to be addressed before deciding to convert or not to convert include:

• What is your expected tax bracket in retirement? Consider how various sources of retirement income (e.g. Social Security, pension, portfolio distributions, etc.) will affect your tax bracket. Converting to a Roth IRA will likely reduce your taxable income and therefore your tax bracket in retirement, as your required minimum distributions will be lower or eliminated. This is one reason the Roth IRA conversion is potentially a “Catch-22” situation (i.e. converting now and paying tax at your current tax bracket, then having a low tax bracket in retirement because RMDs are not mandated).
• Will you move to a state with either higher or lower income taxes than the state you now live in? Moving to a lower-tax state makes a Roth IRA conversion less attractive.
• Will your children or a non-spouse in a lower tax bracket inherit your traditional IRA? If so, consider the following scenario to illustrate why a Roth IRA conversion would be a poor financial decision. You convert your traditional IRA to a Roth and pay the conversion tax at your (high) tax rate. Some years later after your death, your non-spouse heirs inherit your Roth IRA. Since inherited Roth IRAs are subject to the same distribution rules as inherited traditional IRAs, your heirs will take required distributions from the Roth IRA but pay no tax (since most Roth IRA distributions are not taxable). If you had not converted, you pay no conversion tax, and the inherited traditional IRA is passed on to your heirs. Those low-tax-bracket heirs will take annual distributions from the traditional IRA they inherited from you (as they would with a Roth IRA) and pay tax at their lower tax rate. In this situation, a Roth IRA conversion may not make sense.
• What is your life expectancy? If the time horizon of your IRA assets is very long — you have a long accumulation period to grow the IRA assets and then a long distribution period when you take RMDs — consider the likelihood of changes in both elected officials and tax rates during the lifetime of your IRA assets (i.e. during your lifetime and the lifetime of your non-charity heirs).
• Would you like to reduce the value of your gross estate for estate tax purposes? The income tax paid at the time of the Roth conversion will reduce your gross estate. In effect, you are prepaying income tax on behalf of future beneficiaries without it counting as a taxable gift.
• If you are already 73, you cannot convert amounts that must be distributed from your traditional IRA for a particular year under the RMD rules. However, you can convert the balance of your IRA.

Year-end tax planning, important in normal times, is even more crucial when you’re considering a Roth IRA conversion.

Partial Roth IRA Conversion

If you think you’re a good candidate for a Roth IRA conversion, but have concerns about future tax rates and whether your assets can sufficiently fund a comfortable retirement, consider a partial Roth IRA conversion. A partial conversion will spread out your risk, allowing you to diversify your assets into various tax buckets. You’ll then have taxable assets (in brokerage accounts), tax-deferred assets (in IRAs and company-sponsored retirement plans), and tax-free assets (in Roth IRAs).

Roth Conversions Cannot Be Reversed

Prior to 2018, it was possible to make a Roth IRA conversion and later change your mind by “recharacterizing” the conversion. The Tax Cuts and Jobs Act of 2017 banned recharacterizations of Roth conversions. It may be best to wait until the end of the year to process the conversion, when expected income and deductions are better known.

Next Steps

The Roth IRA conversion rules are complex. We have discussed this planning strategy with our clients at annual review meetings when appropriate. Your wealth advisor can help with tax planning to determine whether a Roth conversion supports your long-term plan. If you’re not working with an advisor, contact us to get started.

About the Author

Joyce L. Franklin, CPA, CFP® is a Partner and Senior Wealth Advisor at Mission Wealth. She advises employees and executives in tech and human resources on wealth management, tax, and financial planning. She designs, implements, and monitors financial plans, coordinating each client’s goals, values, and risk tolerance.