by Amanda O'Brien | Accounting News, News, Newsletter, Retirement, Retirement Savings
Key Takeaways:
- A Roth conversion moves money from a traditional account into a Roth, taxed now in exchange for tax-free growth and withdrawals later.
- Converting during a temporarily lower-income year, such as between jobs, can let you convert at a lower tax rate.
- A “conversion ladder” — converting smaller amounts over several years to stay within your current bracket — typically beats converting all at once.
- Converting in your peak earning years, or when it would push you into a higher bracket, often doesn’t make sense.
- Because Medicare Part B/D premiums are based on income from two years earlier, a large conversion can quietly raise your Medicare costs.
If you have money in a traditional IRA or 401(k), you’ve probably wondered how much of those savings will eventually go to taxes. A Roth conversion can help reduce future taxes and build a source of tax-free income, but you generally need to pay taxes now to get those benefits later. Here’s a breakdown of the factors at play in determining if this could be a smart move.
What Is a Roth Conversion?
A Roth conversion moves money from a traditional retirement account into a Roth account. You pay taxes on that money now, at today’s rates. In exchange, that money grows tax-free from then on, and you never pay taxes on it again, not even when you withdraw it. Roth IRAs also don’t require the owner to take required minimum distributions (RMDs). Tax-free growth sounds like the right idea, but it isn’t always the best move.
When a Roth Conversion Could Make Sense
A Roth conversion could be the right move when your income is temporarily lower than usual. For example, if you’ve had a slow income year or you’re between jobs, this could be an ideal time to convert some traditional retirement savings at a lower tax rate.
A conversion may also make sense if you expect tax rates to be higher in the future or want to reduce future RMDs. Having money in both traditional and Roth accounts can also give you more control over taxable income during retirement.
Should You Convert Everything at Once?
Converting a traditional IRA all at once could trigger a substantial tax bill and push you into a higher tax bracket. Instead, converting smaller amounts over several years is typically a better move.
A common strategy known as a “conversion ladder” is to convert enough each year to take advantage of your current tax bracket without unnecessarily pushing income into a higher one.
Work with a tax professional to figure out how much you can convert each year without risking a jump to a higher tax bracket.
When You Might Want to Skip a Roth Conversion
If you’re currently in your peak earning years and sitting in a high tax bracket, or if the conversion could push you into a higher tax bracket than your current one, it may not make sense.
Keep in mind that you’ll need to pay the tax bill. Ideally, this should come from savings outside your retirement account. If you use retirement funds to pay the taxes owed, you’ll put a dent in your investments, and you could incur additional tax consequences.
The Medicare Trap
If you are approaching or already enrolled in Medicare, something to keep in mind is that a Roth conversion can quietly raise your premiums.
Medicare Part B and Part D premiums are based on your income from two years earlier. A large Roth conversion adds to your taxable income, which can increase your Medicare premiums. This is exactly why smaller conversions spread over a few years tend to work better for people in or near retirement.
A Roth conversion can be one of the smartest pathways to create tax-free retirement income, but it can also be an expensive mistake if you do it at the wrong time or with the wrong amount. A tax professional can help you assess your income needs, goals, and timeline if you’re considering a conversion.
by Daniel Kittell | Accounting News, News, Newsletter, Retirement, Retirement Savings, Tax Planning - Individual
As markets continue to experience turbulence driven by renewed tariffs, trade tensions, and global uncertainty, you might be rethinking how you save for retirement. One increasingly popular strategy is converting traditional retirement savings into Roth accounts. Although this approach isn’t suitable for everyone, periods of market decline may offer a more financially favorable window to consider such a move. Read on as we discuss this retirement strategy.
Market Volatility Is Reshaping Retirement Strategies
The stock market has been unpredictable lately. Factors like rising interest rates, inflation, and new trade tensions—especially related to tariffs between the U.S. and other countries—have caused ups and downs in investment values. This kind of economic uncertainty can generate doubt about traditional retirement savings plans.
As a result, more people are looking for ways to take advantage of the current market conditions. One popular strategy is to convert traditional retirement savings to a Roth IRA. Doing a Roth IRA conversion when the market is down can help you save on taxes in the future and make the most of a tough market situation.
What Is a Roth IRA Conversion?
A Roth IRA conversion means moving money from a tax-deferred account—like a Traditional IRA or 401(k)—into a Roth IRA. When you do this, you’ll owe regular income taxes on the converted amount for that year. Once in the Roth IRA, your investments can grow without being taxed, and you won’t pay taxes on eligible withdrawals during retirement.
Unlike traditional retirement accounts, Roth IRAs don’t require you to take minimum distributions (RMDs) each year, giving you more control over your money and tax planning later in life.
Why Market Downturns Make Roth Conversions Attractive
When the stock market drops, the value of your retirement investments often goes down too. While that might feel discouraging, it can actually be a smart time to consider a Roth IRA conversion.
Here’s why: when you move money from a Traditional IRA or 401(k) into a Roth IRA, you have to pay taxes on the amount you convert. If your investments are temporarily worth less because of the market downturn, you’ll pay taxes on a smaller amount. Then, when the market recovers, your investments can grow tax-free inside the Roth account.
For example, let’s say your retirement portfolio is worth $100,000, but a market drop brings it down to $80,000. If you convert while the account is lower, you’ll pay taxes on $80,000 instead of $100,000. Later, when the value grows back, you won’t owe taxes on that growth.
It’s a way to turn short-term losses into long-term gains—especially if you believe your investments will recover and grow over time.
Key Considerations Before Converting
While a Roth IRA conversion can be a smart move, it’s not always the right choice for everyone. Several factors should be evaluated before making a decision:
- Current vs. Future Tax Bracket
If you expect to be in a higher tax bracket later in life—either due to RMDs, Social Security benefits, or changes in tax law—converting now at a lower tax rate can be beneficial. On the other hand, if you anticipate a lower income in retirement, the upfront tax cost may outweigh the benefits.
- Ability to Pay the Taxes
Ideally, you should pay the conversion taxes using funds outside of your retirement account. This lets you keep your retirement savings intact and growing tax-free. Using your IRA or 401(k) to pay taxes could reduce your future retirement income and may even result in penalties if you’re under 59½.
- Long-Term Time Horizon
A Roth conversion generally works best when your money can stay invested for many years. This gives your investments time to grow without tax. Because of this, it’s usually more effective for younger savers or anyone who doesn’t need to tap into their funds for at least 10-15 years.
Is Now the Right Time?
With the current ups and downs in the market, this could be a smart time to consider moving funds into a Roth IRA. If your investments have temporarily dropped in value, converting now might reduce the taxes you’ll owe and allow more room for tax-free growth later.
That said, retirement decisions depend on your unique situation. Speaking with a financial planner or tax expert can help you weigh the pros and cons and decide if a Roth conversion supports your long-term financial strategy.
