Should You Convert to a Roth IRA?

Financial advisers devote extensive time and energy debating the pros and cons of Roth conversions with clients. There are a lot of details to consider — more than I can cover in this article. I will cover the basics, but you must consider your personal situation. I recommend you talk with your financial adviser or tax preparer.

The Key Benefit of a Roth

The primary difference between a traditional IRA and a Roth IRA involves taxes. In a traditional IRA, you likely receive a tax deduction the year you contribute, and your money is tax-deferred while it is invested. When you take withdrawals, the amount withdrawn is taxed as income. A traditional IRA requires that you begin annual withdrawals (called Required Minimum Distributions or RMDs) at age 73 (increasing to age 75 in 2033). RMDs begin at approximately 3.7% of the 12/31 value of the prior year at age 73, and increase to almost 5% at age 80 and over 6% at age 85.

Roth IRAs differ from traditional IRAs in that Roth IRAs are tax-free. Your investment can grow tax-free over many years, and the withdrawals are also tax-free. If you leave the Roth IRA to a beneficiary, it is tax-free. Another key difference is that RMDs are not required for Roth IRAs. If you do not need the money during retirement, it can continue to grow in the Roth IRA tax-free for many years.

The Downside So, what’s the catch? The huge negative is that when you convert a traditional IRA to a Roth IRA the amount you convert is taxable as income that year. With a Roth conversion, you are paying the taxes sooner rather than later. This is why I recommend that people consider converting gradually over several years.

At the simplest level, you can look at your current tax bracket and consider whether you expect it to be higher or lower when you are required to begin taking RMDs. You will need to consider your other sources of income, such as Social Security benefits, a pension, an annuity, investment earnings, etc., to estimate your future income during retirement. If you expect your tax rate to decrease during retirement, then you may choose not to do a Roth conversion.

Tax rates are currently low, and the U.S. national debt is at a historic high (over $33 trillion). The tax cuts passed in late 2017 (which were effective Jan. 1, 2018) were scheduled to “sunset” on Dec. 31, 2025, and tax brackets were expected to revert to the higher 2017 levels on Jan. 1, 2026. However, Richard Rubin of The Wall Street Journal wrote last month that it is likely that Congress will extend the tax cuts. If this prediction is accurate, it is great news for folks who are gradually converting a traditional IRA to a Roth IRA —over several years— because the “window of opportunity” (with lower taxes) will be extended.

The Secure Act of 2019 eliminated the “stretch” investors enjoyed for many years when they left an IRA to a beneficiary. (The stretch allowed withdrawals over the beneficiary’s expected lifetime.) Although the stretch is still available to spouses in most cases, the new rule states that traditional IRAs and Roth IRAs must be withdrawn within 10 years when left to a non-spouse beneficiary. Let’s assume you leave your large traditional IRA to a child or grandchild. The withdrawals are fully taxable as income and may be taxed at a high rate if the child or grandchild is in their peak earning years. When a Roth IRA is inherited, it must also be withdrawn within 10 years, but the withdrawals are not taxable.

Reasons You May NOT Want to Convert

• Your traditional IRA is not large, and you expect to need the money for expenses during retirement.
• You plan to leave your traditional IRA to charity when you die (charities are not taxed).
• You expect your future tax rate during retirement to be less than your current tax rate.
• You expect your children or grandchildren to be in a low tax bracket when they inherit your traditional IRA.
• You expect Congress to change the rules — and tax Roth IRAs in the future.

Reasons to Consider a Roth Conversion

• You will not need the RMDs during retirement for living expenses.
• You want to leave your IRA — or a portion of it — to children or grandchildren tax-free.
• Your traditional IRA is significant, and the required RMDs will be large enough to result in higher taxes throughout retirement (this has been termed a “tax bomb”).
• Your traditional IRA RMDs will be large, and will cause your Medicare-related IRMAA (income-related monthly adjusted amount) to be higher throughout your retirement.
• You expect your tax rate to be higher during retirement than it is now.

A Few More Details and Tips

• Roth conversions can be done in any amount in any year. There are no income limitations.
• You must maintain a Roth IRA from a conversion for five years before taking withdrawals. The five years begin on Jan. 1 of the year you convert, and a new five years begin with each conversion. Therefore, if you expect to need the money in less than five years, do not do a Roth conversion. (When doing a Roth conversion over several years, only one Roth IRA account is required. Your brokerage firm will track the dates of each conversion.)
• It is best to pay the taxes from an after-tax account. If you pay the taxes from the IRA, it requires that you withdraw a larger amount, which increases your income taxes that year.
• Roth conversions are allowed any year, even after beginning RMDs. The RMD must be withdrawn first, and then Roth conversions (in any amount) are allowed in the same tax year.
• If you are charitably inclined, some of the taxes triggered by a Roth conversion can be reduced with charitable gifts in the same year. However, this requires that you itemize deductions on your tax return.
• There are other ways to build a Roth IRA than converting from a traditional IRA. I recommend contributing to the Roth IRA portion of a 401(k) or 403(b) through your employer retirement plan and funding a Roth IRA directly if you meet the income requirements.
• Roth conversions for the 2023 tax year must be completed by Dec. 31, 2023.

Not All or Nothing

Roth conversions are allowed for any amount. Let’s assume you are age 45 and have a $250,000 traditional IRA that you would like to convert to a Roth IRA. You may decide to convert $25,000 in 2023, and then decide in future years if you want to convert larger amounts. Converting a small portion will allow you to see the taxes that are triggered when you prepare your 2023 taxes next spring.

Or, let’s assume you are age 58 and planning to retire at 62. You may want to start converting now, recognizing you have a window of opportunity to convert before you begin Medicare at age 65 (and encounter potentially higher IRMAA charges) and before you decide to start social security benefits (presumably at age 67-70).

Steven Jarvis, CPA is a retirement tax specialist and a fan of Roth conversions. Recognizing we do not know what future tax rates may be, he states: “Removing tax uncertainty is an advantage in and of itself.”

The tax-free Roth IRA “bucket” provides a retiree with an additional pool to draw from during retirement if the money is needed, and leaving it to a child or grandchild tax-free makes it even more powerful.

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Donna Skeels Cygan, CFP?, MBA, is the author of?The Joy of Financial Security. She owned a fee-only financial planning firm for over 20 years and is now writing a new book, Woman’s Playbook, that will be published in 2024.