Roth IRA conversions can be a powerful wealth-building strategy, but they’re not right for everyone. Here’s how to evaluate if a conversion makes sense for you.
A Roth IRA conversion involves moving assets from a traditional IRA or employer retirement plan into a Roth IRA, where they can grow tax-deferred and be withdrawn tax-free in retirement.
While this strategy can offer significant long-term benefits, it comes with an immediate tax bill that requires careful consideration.
These three questions will help you determine whether a Roth IRA conversion may be right for you.
Question 1: When Will You Need the Money?
Understanding when you’ll need to access your retirement funds is essential to evaluating whether conversion is right for you.
If you need the funds within the next 5 years…
A Roth conversion probably isn’t appropriate if you’ll need the money in the near term to maintain your current standard of living. Converting means paying taxes up front, which reduces the funds available to you now, and you won’t have sufficient time for the tax-free growth to outweigh the upfront tax cost.
If you won’t need the funds for 5+ years…
If you don’t anticipate needing the money for at least five years or longer, a Roth conversion becomes much more attractive. The funds can grow tax-free over your lifetime, potentially for decades. The longer your money stays invested, the more valuable this tax-free growth becomes.
This question also ties into your legacy planning goals. If you’re thinking about leaving assets to heirs rather than spending them yourself, a Roth IRA provides a tax-free inheritance that can be significantly more valuable than leaving a traditional IRA.
Question 2: Where Will the Money Come from to Pay the Taxes?
When you convert traditional IRA assets to a Roth IRA, the conversion amount is added to your taxable income for that year. This tax liability is often the biggest hurdle in deciding whether to proceed.
In nearly all cases, you should use funds from outside sources (non-retirement accounts) to cover the conversion tax. When you pay with separate funds, the full converted amount can remain in the Roth IRA to grow tax-free.
Why? If you use retirement account funds to cover the tax bill, you’re reducing the amount that can benefit from tax-free growth. Additionally, if you’re under age 59½, using retirement funds could trigger early withdrawal penalties on that portion.
Question 3: What Do You Expect Future Tax Rates to Be?
Comparing your current tax rate to what you expect in retirement is crucial to the conversion analysis.
If you expect rates to be the same or higher…
Converting now may be more advantageous because you’re paying tax at today’s rate rather than a potentially higher future rate. This is particularly relevant given that the One Big Beautiful Bill Act (OBBB) extended current tax rates only through 2029, after which they could increase.
If you expect rates to be significantly lower…
You may want to forgo conversion and take advantage of lower tax rates in the future when you take distributions. This might apply if you expect substantial income drops in retirement or have other factors that will significantly reduce your taxable income.
Circumstances that favor conversion…
You may have favorable tax attributes in a particular year that make conversion especially attractive, such as large charitable deductions, net operating losses, or tax credits that can offset some or all of the conversion tax.
Here’s one scenario where conversion may not be appropriate. If you plan to name a charity as your IRA beneficiary, conversion becomes less compelling since charities don’t pay income taxes on inherited IRA assets anyway.
Making the Right Decision for Your Situation
Roth conversion decisions can affect your current tax bracket, Medicare premiums, estate plan, and retirement income strategy.
But at Prosperity Capital Advisors (Prosperity), our holistic planning process helps ensure Roth conversion decisions align with every aspect of your financial life and situation.
Work with our tax professionals to model different conversion scenarios, evaluate the trade-offs specific to your situation, and develop multi-year conversion strategies that optimize your long-term wealth.
Wondering if a Roth conversion is right for you?
Find a Prosperity advisor to discuss your situation and explore whether this strategy fits into your retirement plan.
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This material was developed and produced by Ed Slott and Company, LLC to provide information on a topic that may be of interest. Ed Slott and Company, LLC is not affiliated with The JL Smith Group or Prosperity Capital Advisors (Prosperity).
