March 1, 2023

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There has been a lot of talk about the merits of converting traditional IRA funds to a Roth IRA. In my 25+ years of being a CPA and financial advisor, I know that this concept is definitely situational. Below are few scenarios when it might be to your advantage to convert traditional IRA funds to a Roth IRA (keep in mind you must pay income taxes on any converted funds in the year of the conversion).

Who should consider converting to a Roth IRA?

• You believe your tax bracket will be higher in retirement. In this scenario, paying taxes at your current tax rate is preferable to paying a higher rate after you’ve stopped working. Paying higher taxes in retirement may sound farfetched, but it’s possible, especially if you haven’t yet hit your peak earning years or have accumulated significant savings in your retirement accounts.
• You want to maximize your estate for your heirs. If you don’t need to tap your IRA funds during your lifetime, converting from a traditional to a Roth IRA allows your savings to grow undiminished by Required Minimum Distributions  (“RMD”), potentially leaving more for your heirs, who can generally withdraw the money tax-free as long as they follow IRS distribution rules. 
• Your accounts aren’t diversified by tax treatment. That is, most of your assets are in tax-deferred accounts. By converting to a Roth IRA, you’ll have assets that won’t be taxed when withdrawn, potentially allowing you to better manage your tax brackets and enable more personalized tax planning during retirement.
• You have irregular income streams and lower than usual income this year. For example, you might have been in between jobs and had multiple months with no income. Or you recently retired but haven’t started taking RMD’s yet,so your marginal tax rate is low.

Who should not consider converting to a Roth IRA?

For some people, sticking with a traditional IRA or other tax-deferred accounts might be a better strategy in the following situations:

• You’re nearing—or in—retirement and need your traditional IRA to cover your living expenses. Money that you’ll need soon isn’t a good candidate for conversion, because in order for a Roth conversion to be tax-free, you have to wait 5 years before taking any withdrawals from the Roth.
• You’re currently receiving Social Security or Medicare benefits. If a Roth conversion were to increase your taxable income, then more of your Social Security benefits would be taxed and your Medicare costs could rise. This still may make sense if you are in a lower tax bracket.
• You don’t have money to pay the conversion tax or must sell assets that could lead to an additional tax hit. Using IRA funds to pay for the conversion tax could negate the benefits of converting (more on that below). A better option would be paying the tax with cash on hand. If you must sell assets in a taxable account to cover your conversion tax, it is best to focus on those without taxable gains or at least a high-cost basis. 
• You plan on giving a substantial amount of your traditional IRA to charity using a Qualified Charitable Distribution (QCD). Some retirees use this strategy to satisfy their RMD without creating taxable income. In this case, converting to a Roth IRA could be counterproductive since you wouldn’t avoid taxes as you would with just a QCD.

In conclusion, the optimal time to convert a traditional IRA to a Roth IRA is during the period after retirement and before RMD’s when there is a window of low marginal tax rates. 

It’s best to consult with your CPA and financial advisor to determine if this strategy makes sense for you.  

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Important Disclosures:

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