Roth IRA Conversions: When They Make Sense - and When They Don’t

Roth conversions are one of the most talked about tax strategies right now. I’ve seen more interest in the past year than at any time since the income limits on conversions were eliminated in 2010. While “pay tax now, avoid tax later” sounds simple, the reality is more nuanced. Whether a conversion makes sense depends entirely on your situation. It’s a planning decision, not a default move.

What is a Roth IRA Conversion

A Roth IRA conversion is the process of moving funds from a traditional IRA to a Roth IRA. The portion of the conversion attributable to pre-tax IRA contributions and earnings is taxable income in the year converted.

Why Consider a Roth Conversion

Roth IRAs do not have required minimum distributions (RMDs), which is one of the primary reasons taxpayers consider converting. Reducing future RMDs from a traditional IRA can hedge against higher tax rates later in life.

Roth IRA funds grow tax-free, and withdrawals are tax-free as long as the account has been open at least five years and you are 59 ½ or older.

There are also estate planning advantages, as beneficiaries generally receive distributions income tax free, though distribution timing rules still apply.

The Key Tradeoff

The key question to consider: will your tax rate now be lower than your tax rate in the future?

For example, converting at a 24% tax rate today and withdrawing later at 32%, is a win. Converting at 32% today and withdrawing later at 22%, not so much.

When it May Make Sense

• Lower-income years (e.g., early retirement, gap years)

• Over age 59 ½ but before RMDs begin (typically before age 73 or 75, depending on year of birth)

• If you expect higher future tax rates, such as when you have:

  • Large retirement account balances

  • Pension income

  • Significant investment income

• When you have cash available to pay the tax (not using IRA funds)

• As part of an estate planning strategy

When it May NOT Make Sense

• You’re already in a high tax bracket

• You expect lower income (and lower tax rates) in retirement

• You don’t have outside funds to pay the tax

• The conversion pushes you into:

  • Higher tax brackets

  • Medicare premium surcharges (IRMAA)

  • Net investment income tax thresholds

• You may need the funds in the near term

Hidden Factors Often Overlooked

To make the right decision, it is important to consider the impact on Medicare premiums (including the two-year IRMAA lookback), as well as the taxation of Social Security benefits. Higher income in conversion years can also affect the phaseouts of certain deductions and credits.

State income taxes should not be overlooked, particularly if you plan to relocate in retirement.

There are two separate 5-year rules for Roth IRAs. The first determines whether earnings can be withdrawn tax free. The second applies to each Roth conversion separately and determines whether a 10% early withdrawal penalty applies to converted amounts. This rule is primarily relevant for individuals under age 59 1/2, as the penalty no longer applies once that age is reached.

It Doesn’t Have to Be All or Nothing

Partial conversions over several years–often called “bracket management”–may be more effective than one large conversion.

What “Good Planning” Looks Like

Good planning means evaluating your current income, future projections and expected tax brackets. Tax projections can help determine how much to convert and when.

In summary, Roth conversions can be powerful, but only when used strategically. This is no one-size-fits-all answer. If you are considering a conversion, let’s work together to determine whether it makes sense for your situation and how to implement it effectively.