A Roth conversion is a process by which you convert funds from a traditional IRA or 401(k) into a Roth IRA. This conversion is subject to income taxes, but the money in the Roth IRA will grow tax-free and withdrawals will be tax-free.

Many high earners are not able to contribute to a Roth IRA because they have income limits. A Roth conversion can provide an effective alternative that is not subject to IRS limits.

When might a Roth conversion make sense? Here are five main reasons you should consider doing a Roth conversion.

Down Market
It often makes sense to initiate a Roth conversion when the market is down. If you sell assets in a traditional IRA when the account value dips, you will be paying taxes on a lower dollar amount. Assets can then be reinvested in your Roth IRA, and future potential gains are tax free.

For example, let’s say your IRA was worth $100,000 at the beginning of the year. Due to the market decline, the value has dropped to $80,000. If you do the Roth conversion now, you’ll owe taxes on $80,000 instead of $100,000. By reinvesting in a Roth IRA, you have the potential to benefit from a market rebound tax-free.

Low Tax Bracket
The Tax Cuts and Jobs Act of 2017 lowered tax brackets for nearly everyone, but these lower rates are set to expire at the end of 2025.

current vs 2026 tax brackets

A common strategy is to max out the lowest tax brackets. For example, if you’re married and retired with no income and want to do a Roth conversion, then the first $20,550 is taxed at 10%, the next $63,000 is taxed at 12%. During your working years your effective tax bracket was likely much higher and now you can take advantage of the lower brackets.

Tax Diversification
It’s common for people to have most of their retirement savings in tax deferred accounts (401(k), IRAs, etc.). By converting to a Roth IRA, you’ll have assets that won’t get taxed when withdrawn. This will allow you to better manage your tax brackets and provide you with more flexibility when tax planning in retirement.

Reduce RMDs
When you reach age 72, you are required to withdraw money from your tax deferred retirement accounts (IRAs, 401(k), 403(b)s etc). Required minimum distributions (RMDs) can force investors to draw down a portion of their retirement assets even when they do not need the money.

A conversion of your eligible amounts to a Roth IRA can reduce or eliminate your need to take RMDs in the future. Ideally, you are looking to balance the taxes paid today as a result of the conversion versus your long-term tax savings down the line.

Minimize Taxes to Heirs
Roth conversions can also be used to reduce the size of a taxable estate. Money converted to a Roth is removed from the taxable estate, leaving heirs with the full balance of the retirement account without any tax liability owed upon distribution. This can be especially beneficial for those with large estates.

Bottom Line
The decision to convert to a Roth IRA doesn’t have to be all or nothing. You may find having a portion of your retirement assets in a Roth and Traditional IRA is optimal for you. Consult with a qualified financial advisor to determine whether this strategy may be appropriate for you.

George Maroudas
Twitter @ChicagoAdvisor

Disclaimers / Sources:

Tax Brackets from IRS.gov

The first five-year rule states that you must wait five years after your first contribution to a Roth IRA to withdraw your earnings tax free.

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.

Traditional IRA account owners have considerations to make before performing a Roth IRA conversion. These primarily include income tax consequences on the converted amount in the year of conversion, withdrawal limitations from a Roth IRA, and income limitations for future contributions to a Roth IRA. In addition, if you are required to take a required minimum distribution (RMD) in the year you convert, you must do so before converting to a Roth IRA

Contributions to a traditional IRA may be tax deductible in the contribution year, with current income tax due at withdrawal. Withdrawals prior to age 59 ½ may result in a 10% IRS penalty tax in addition to current income tax.

This information is not intended to be a substitute for specific individualized tax advice. We suggest that you discuss your specific tax issues with a qualified tax advisor.