When you first set up your retirement account, you probably had to make a big decision: Should I go with a Roth or a traditional account? Both options come with their own benefits, but what if you’re now wondering if a Roth conversion might be the right move for you? If you’re sitting on a traditional IRA or 401(k) and are thinking about switching to a Roth, let’s break it down.
Here’s the scoop on Roth conversions, and why you might want to consider making the switch. We’ll go over how they work, the potential benefits, and how you can make sure it’s the right choice for your financial future.
What Exactly Is a Roth Conversion?
A Roth conversion is exactly what it sounds like—you’re converting money from a traditional retirement account (like a traditional IRA or 401(k)) into a Roth account. When you make the conversion, you’ll pay taxes upfront on the amount you’re moving over. The upside? Once it’s in the Roth, you won’t have to pay taxes on that money again when you make withdrawals in retirement.
One of the key reasons people love Roth accounts is that they come with some unique advantages. For example, Roth IRAs and Roth 401(k)s don’t have required minimum distributions (RMDs), like traditional accounts do. This means you can let your money grow tax-free for as long as you want, without worrying about being forced to take money out at a certain age.
How Does a Roth Conversion Work?
To convert a traditional account to a Roth, you have a few options, according to the IRS. You can:
- Have your plan administrator handle the conversion for you.
- Request that the institution holding your account transfers the funds to another account.
- Have the funds sent to you directly, and then roll them over into a Roth account yourself within 60 days.
Regardless of the method you choose, one thing stays the same: when you convert, you’ll owe taxes on the funds you’re moving over. This means if you’re converting $50,000, for example, that $50,000 is added to your taxable income for the year, and you’ll pay income tax on it.
Should You Convert Based on Your Income?
One of the best times to do a Roth conversion is when your income is lower than usual. Why? Because the amount you convert is taxed as income, and the lower your income for the year, the lower your tax bracket will be. If you’ve had a year off, worked part-time, or had a sabbatical (or even if you just didn’t have a big bonus or raise), this could be the perfect time to make the switch.
The idea is simple: pay taxes now when you’re in a lower tax bracket, and enjoy tax-free withdrawals later when you retire. Plus, once the money is in your Roth account, you won’t have to worry about paying taxes on it ever again—no matter how much it grows over the years.
How a Roth Conversion Can Help You in the Long Run
The real draw of a Roth conversion is what happens down the road. Imagine this scenario: You’ve converted your traditional retirement account to a Roth and paid your taxes on that money now. When you reach retirement, all the money you’ve invested in the Roth account will come out tax-free. And since Roth accounts don’t have RMDs, you won’t be forced to withdraw money if you don’t need it.
This can be a huge advantage for people who want to pass on their wealth to heirs or keep their money growing for as long as possible. You’re not bound by any minimum withdrawal rules, so you can let the funds continue to grow without worrying about the government requiring you to take distributions.
When Should You Consult a CERTIFIED FINANCIAL PLANNER™?
A CERTIFIED FINANCIAL PLANNER™ (CFP®) can be incredibly helpful when you’re considering a Roth conversion. They can run scenarios to show how the conversion will affect your current tax situation and what your future tax burden might look like. A financial planner can also help you decide whether a Roth conversion makes sense based on your long-term financial goals.
Since the decision to convert can be complex, especially when factoring in taxes, working with a CFP® ensures that you’re making the best choice for your personal financial situation.
Pros and Cons of a Roth Conversion
Like most financial decisions, Roth conversions come with both pros and cons. Here are some of the main points to consider:
Pros:
- Tax-free growth: Once the money is in the Roth, you won’t owe taxes on it again.
- No RMDs: You won’t be forced to withdraw funds at a certain age.
- Tax diversification: Having both Roth and traditional accounts gives you flexibility in retirement, especially when it comes to taxes.
Cons:
- Upfront tax hit: You’ll owe taxes on the amount you convert.
- Tax brackets matter: If you convert a large sum in a high-income year, it could push you into a higher tax bracket.
- It’s irreversible: Once you convert, there’s no turning back. If you don’t like the tax consequences, you can’t undo the conversion.
Is a Roth Conversion Right for You?
If you’re looking to minimize taxes in retirement, maximize your account’s growth potential, and have more control over your withdrawals, a Roth conversion might be worth considering. But it’s not the right move for everyone. Your income level, tax situation, and long-term goals all come into play.
Ultimately, the decision to convert depends on your unique financial circumstances. Before making any moves, be sure to chat with a CERTIFIED FINANCIAL PLANNER™ to help guide you through the process.