Is a Roth IRA Conversion Really a Good Idea?

The upside and possible negatives of converting a traditional IRA to a Roth IRA

Roth Conversion Bloomington Normal IL

If you own a traditional IRA, perhaps you have thought about converting it to a Roth IRA.  Going Roth makes sense for some traditional IRA owners, but not all. 

Why go Roth? There is an assumption behind every Roth IRA conversion – a belief that income tax rates will be higher in future years than they are today. If you think that will happen, then you may be compelled to complete a Roth Conversion. After all, once you are age 59½ and have had your Roth IRA open for at least five years (five calendar years, that is), withdrawals of the earnings from your Roth IRA are exempt from federal income taxes. You can withdraw your Roth IRA contributions tax free and penalty free at any time.

Additionally, you never have to make mandatory withdrawals from a Roth IRA. The required distributions from traditional retirement accounts starting at age 72 is one of the biggest reasons you may bump up to a higher income tax bracket in your retirement years. This can be avoided through Roth IRAs.

Roth Conversion is especially useful for those who are unable to make annual contributions to ROTH IRAs due to their income. For 2022, the income phaseout ranges begin at $144,000 for single filers and $214,000 for joint filers; these numbers represent modified adjusted gross income.

While you may make too much to contribute to a Roth IRA, you have the option of converting a traditional IRA to a Roth. There currently is no income requirement for converting a traditional IRA to a Roth. Imagine never having to draw down your IRA each year. Imagine having a reservoir of tax-free income for retirement (provided you follow Internal Revenue Service rules). Imagine the possibility of those assets passing to your heirs without additional income tax. The passing of the SECURE Act has made ROTH Conversion much more appealing since non-spouse beneficiaries no longer have the option to keep the account tax deferred over their lifetime, subject to an annual distribution. Instead, the entire balance of the Traditional IRA/ 401k must be disbursed and taxed to beneficiaries within 10-years of the account owner's death.

So ROTH Conversion sounds great, right? It certainly does – but the question is: can you handle the taxes that would result from a Roth conversion? While there are in-depth calculations required, as a financial planning office, McBeath Financial Group specializes in such analysis.

Why not go Roth? Although we can typically show you many reasons to favor a ROTH Conversion, here are two reasons to consider: the tax hit could be substantial, and time may not be on your side.

A Roth IRA conversion is a taxable event, the conversion amount is added to your taxable income. The increase in taxable income could send you into a higher income tax bracket in the year when the conversion occurs.

HINT: We explore this option in the course of financial planning. We want to help you make strategic decisions based on tax planning. If a Roth Conversion is beneficial for you, we want to structure the conversion to take advantage of lower tax brackets early on, so that your aren't subject to even higher tax rates once Required Minimum Distributions begin.

If you are nearing retirement age, going Roth may not be worth it. For most people, there is a sweet spot from the time you retire until RMD age where you are in a lower tax bracket. This is the timeframe that is usually most advantageous for converting. Even if you convert during this timeframe (normally your 60s), it may take a decade (or longer) for the IRA to recapture the dollars lost to taxes on the conversion. Model scenarios considering “what ifs” should be mapped out

HINT: With advanced planning, we can determine the overall value to be gained by conversion. In your 50's or 60's, you have time to convert before your RMD's begin. Typically, RMD's cause your tax brackets to rise significantly, which creates more tax. In addition, your higher income creates higher Medicare Premiums. Although taxes increase during the conversion, there is typically tax savings over your lifetime AND you can save money on future Medicare premiums. And the best part, if you have children, they benefit too because you are able to pass more on to them tax-free.

In many respects, the earlier in life you convert a regular IRA to a Roth, the better. Your income should rise as you get older; you will likely finish your career in a higher tax bracket than you were in when you were first employed. Those conditions relate to a key argument for going Roth: it is better to pay taxes on IRA contributions today than on IRA withdrawals tomorrow.

On the other hand, since many retirees have lower income levels than their end salaries, they may retire to a lower tax rate. That is a key argument against Roth conversion.

HINT: Although you may retire in a lower tax bracket, we typically see this doesn't last long. Again, those RMD's will likely drive up tax rates and premium in the future. We suggest you use this time to your advantage. Advanced Planning can show you the value of this!

If you aren’t sure which argument to believe, it may be reassuring to know that you can go Roth without converting your whole IRA.

You could do a multi-year conversion. Is your traditional IRA sizable? You could spread the Roth conversion over many years. This can help reduce or eliminate the balance in the Traditional IRA/ Roth 401k before mandatory distributions begin. This could potentially help you avoid higher income taxes on some of the income from the conversion.

If you are interested in Roth Conversion, we recommend a comprehensive financial analysis before making this decision. We can help! Call us at 309-808-2224.

Krista McBeath is an Investment Advisor, Chartered Financial Consultant, a Licensed Insurance Advisor, a Fiduciary, and an experienced tax advisor who specializes in financial planning, investments, and insurance.

She utilizes advanced tools for in-depth calculations that analyze tax and retirement scenarios to help their clients avoid a future tax time-bomb.  Whether this means enjoying more of your hard-earned money in retirement or passing along assets to loved ones, with less tax burden, planning makes the difference.

Her new book, The Generational Wealth System outlines a holistic approach to preserving lifestyle, wealth and legacy.

click to schedule an appointment with financial planner Krista McBeath of Normal IL