Is a Roth IRA Conversion Right for You?

Authored by Carli J. Harvey and Susan St. Range, CPA

Should I convert my retirement plan to a Roth IRA? It's an important question, particularly considering the Biden administration's intent to raise taxes on high-earning individuals. Given the often-sizable nest egg that people have accumulated during their careers, converting to a Roth IRA may be a smart move.

Roth vs. Traditional: What's the Difference? 

Taxes now or taxes later. Simply put, that is the main difference between a Roth and Traditional IRA.  

Contributions to a Roth IRA are made post-tax, but withdrawals are made tax-free. This means no tax advantage to you now, but all of those dollars and the growth on top won’t hit your tax bill later down the road. The catch being, while contributions can be withdrawn at any time tax-free, earnings from the IRA cannot be withdrawn without penalty until age 59?. This is meant to be a retirement vehicle. There are is also the 5-year rule to consider.   

On the other hand: Contributions to a traditional IRA are made pre-tax now. But later down the road withdrawals are taxed as ordinary income. Individuals must wait until age 59? to begin withdrawing funds without penalty and are required to start taking minimum distributions at age 72. Therefore, a Roth IRA is often beneficial for individuals who expect to be in a higher tax bracket in the future. Those individuals can contribute now at a lower tax rate and then avoid paying taxes at a higher rate in the future. Conversely, a traditional IRA is often beneficial if the individual will be in a lower tax bracket in the future. 

Here is the kicker and may be a difference maker for you…especially if you don’t foresee using your entire retirement fund, and prioritize leaving some for heirs. When it comes to estate planning, a Roth IRA may have two significant benefits. First, a traditional IRA forces an individual to take minimum distributions and pay taxes on those distributions, even if they don't need them. A Roth IRA does not require any distributions. Second, a Roth IRA enables an individual's heirs to withdraw funds tax-free, whereas the beneficiaries of an inherited traditional IRA will incur taxes on distributions at their ordinary income tax level.  

Cost of Conversion

When an individual converts a traditional IRA to a Roth IRA, the contributions and earnings in the traditional IRA account will be considered ordinary income and taxed as such.  

An individual must also be aware that the income realized from the conversion could push them into a higher tax bracket for the year and thus must make those calculations.  

We have a saying on the Private Wealth team, “never let a low tax year go to waste.” If you have a job transition or outlier low income year, that is a great time to look at conversion opportunities. Also if you happen to be in that sweet spot-- retired but younger than 72 and therefore not required to take RMDs yet-- this can be a golden opportunity to look at conversion strategies since you will have more control than ever around your income levels.  

Fortunately, there are no penalties for conversions, so even younger account holders will avoid the typical 10% that the IRS charges for early retirement withdrawals. 

Tax Rates and Considerations

Which will be higher: your tax burden now, during conversion, or your tax burden during retirement, when you take distributions? That's the million-dollar question. 

The Tax Cuts and Jobs Act reduced individual income tax rates from 2018 through 2025. Unless Congress enacts new legislation to cut taxes, rates will increase in 2026. Furthermore, the Biden administration would like to pass legislation increasing both spending and taxes.  

Regardless of how Congress affects future tax rates, an individual may experience a higher or lower future tax rate purely due to their future income level. An individual who is early in their career or a shareholder in a growing company may have higher earnings in the future and be pushed into a higher tax rate.  

Future tax rates are important for those who plan on taking distributions during retirement. However, individuals who don't plan on taking distributions and instead want to leave the funds for their heirs would benefit from a Roth IRA. Heirs are not taxed on Roth accounts and will also have several options for withdrawing funds from it. 

As you can see, there are many things to consider when it comes to retirement planning and potentially converting your traditional IRA to a Roth IRA. This article only provides a high-level overview and is not a substitute for speaking with one of our expert advisors. KDP is different because we both tax and wealth expertise together when planning a strategy for your customized plan. Please get in touch with our office if you would like to discuss your specific situation and determine the best path for you and your family. We're always happy to help.