When you’re planning for retirement, one important consideration is how taxes can impact your financial picture. A Roth conversion is a strategy that can help you manage your taxes over the long term. But what is a Roth conversion, how does it work, and why might it make sense for you? Let’s dive in.
What is a Roth Conversion?
A Roth conversion is when you move money from a traditional IRA or 401(k) to a Roth IRA. Traditional accounts let you defer taxes until retirement, when withdrawals are taxed as ordinary income. In contrast, Roth IRAs require you to pay taxes upfront, but qualified withdrawals which are withdrawals made after age 59½ and once the account has been open for at least five years are completely tax-free.
When you convert funds to a Roth IRA, you pay taxes on the amount you convert now. After that, the money can grow tax-free and you’ll never owe taxes on it again if you follow the rules. This can be a powerful way to help secure more tax-free income for your retirement.
Why Consider a Roth Conversion?
One key reason to think about a Roth conversion is if you expect your tax rate to be higher in the future. Maybe you think taxes will go up in general, or you plan to have more income later on. Paying taxes now could save you money in the long run.
Roth IRAs also don’t have required minimum distributions (RMDs), which traditional retirement accounts do. This means you have more control over how and when you use your retirement savings. It can also help you manage your taxes more effectively in retirement.
Important Considerations Before Converting
Even though there are benefits, it’s important to think carefully before doing a Roth conversion. Here’s why:
- Tax impact today: The money you convert is added to your taxable income for that year. If you convert a large amount, it could push you into a higher tax bracket temporarily. That’s why it’s often better to convert in smaller chunks over several years.
- How to pay the taxes: Ideally, you should pay the tax bill with money outside your retirement account. If you use funds from the converted amount to pay taxes, you’ll end up with less in your Roth IRA and reduce the benefits.
- Impact on other costs: A higher income in the year you convert can also affect your Medicare premiums or how much tax you pay on Social Security benefits.
Time horizon: Roth conversions often work best when you have enough time to let the money grow tax-free, typically at least 5–10 years.
How We Can Help
A Roth conversion isn’t right for everyone—it depends on your unique situation, goals, and tax picture. When we work with clients, we:
- Review your current tax bracket and how a conversion could affect it
- Look at your retirement income sources, like Social Security, pensions, and investments
- Consider your estate planning and legacy goals
- Test different scenarios to see how a Roth conversion would impact your taxes and retirement income
By taking a close look at your overall plan, we help you decide if a Roth conversion fits your financial future.
Bottom Line
A Roth conversion can be a smart move for some retirees and pre-retirees, but it’s not a one-size-fits-all solution. It’s a tool that should be part of a broader retirement and tax plan, not a quick fix.
If you’re curious about whether a Roth conversion might work for you, let’s connect. We’ll talk through the pros, the cons, and what makes the most sense for your unique financial journey.
Reference:
IRS: Roth IRAs: https://www.irs.gov/retirement-plans/roth-iras
Securities offered through Valmark Securities, Inc., a member of FINRA/SIPC.
Investment Advisory Services offered through Valmark Advisers, Inc. a SEC Registered Investment Advisor 130 Springside Drive, Suite 300 Akron, Ohio 44333-2431 1-800-765-5201.
Velekei Giles Financial Advisors is a separate entity from Valmark Securities, Inc. and Valmark Advisers, Inc.
This material is for informational purposes only and is not intended provide specific advice or recommendations for any individual nor does it take into account the particular investment objectives, financial situation, or needs of individual investors. This information is not intended for use as tax advice. Persons should consult with their own tax advisors for specific tax advice.