Roth IRAs: When to Convert From a Traditional IRA

Roth IRAs are a powerful retirement-savings vehicle, but should you trade in your traditional IRAA type of account in which funds can be saved and invested without being subject to tax until the account holder reaches retirement age. for one? The answer comes down to taxes.

Roth IRAs are popular because your money not only grows tax-free but can also be withdrawn during retirement without paying taxes—whereas money in a traditional IRA grows tax-free but you have to pay taxes once you begin the withdrawal process.

As attractive as tax-free growth and withdrawals are, Roth IRAs aren’t a free lunch. If you want to make the switch from a traditional IRA, you have to pay income taxes on the amount of money you move. This means that timing and tax rates should be crucial factors in your decision.

Here are six considerations as you contemplate whether a conversion makes sense for you:

1. Time Frame. In general, the longer you have before you need the money, the more sense it makes to convert assets to a Roth IRA. Once you convert to a Roth, qualified withdrawals will never be taxed. Leaving those assets untouched to grow tax-free for as long as possible allows you to get the most juice out of the conversion.
2. Tax Rate. Try to switch to a Roth IRA at the lowest tax bracket possible. For instance, if you have a low-income year, perhaps due to early retirement, or you anticipate moving into a higher tax bracket in future years, it may make sense to time a Roth conversion around those events.
3. Paying for the Conversion. If taxes on the conversion are paid from IRA money, less is left in the Roth to grow, eroding the benefit of the conversion. The best practice is to cover the tax bill from cash on hand or taxable investments. If tapping your current IRA assets to pay the taxes is your only option, converting might be unwise.
4. Required Minimum Distributions (RMDs). You are required to withdraw money from traditional IRA accounts starting at age 72 (70½ for those who reached that age before Jan. 1, 2020), but you are not required to take money out of a Roth. If you don’t need to tap into IRA funds to cover living expenses, a Roth IRA gives you the freedom to choose when or if you take withdrawals over your lifetime.
5. Legacy. Roth IRAs are a better asset to pass on to your heirs than traditional IRAs. Where traditional IRAs create taxable income, heirs don’t have to pay taxes on Roth IRAs, and they have more flexibility in drawing down the account over time. In other words, your heirs will thank you if you convert to a Roth.
6. Where You’ll Live in Retirement. Individual states tax retirement income differently. If you plan to move to another state in retirement, check to see whether required distributions from IRAs are excluded from your state income tax. If so, you may save more on taxes by sticking with a traditional IRA than you would converting to a Roth.

Converting to a Roth isn’t a cut-and-dried decision. If you have questions, please contact your wealth management team. We are here to help.