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What is a Roth Conversion and should I do one?

What is a Roth Conversion and should I do one?

October 01, 2022

If you read any investment publications, you've likely heard about something called a "Roth conversion". You may be wondering what a Roth conversion is, and if you should be utilizing this strategy. 

Let's start with how a Roth account is fundamentally different from other types of retirement accounts. 

If you have a Traditional IRA, your account is considered a "pre-tax" account, meaning the funds in the account have not been taxed yet. You get a tax deduction the year the contributions go in, but the funds will all be taxable when you pull them out. In the meantime, your money has the potential to grow "tax-deferred", meaning that any growth or earnings in your account are also taxable, but not until you pull them out. 

If you have an employer-sponsored retirement account such as a 401(k), 403(b), 457, etc, it is likely pre-tax as well, though Roth options are becoming more popular. 

A Roth account is different in that the funds are considered "after tax". Your taxable income for the year will not decrease just because you make a Roth contribution. The benefit comes later on down the road when you go to pull funds out. You can pull out your contributions tax and penalty free, and if you wait until you have met certain requirements, any growth and earnings in your account are also tax free!*  

So what is a Roth conversion? A Roth conversion is where you take funds from a pre-tax account and convert them to a Roth account. The amount you convert will count as taxable income for the year you make the conversion. What are some of the reasons you may want to make a Roth conversion? 

You aren't eligible to make contributions directly to a Roth account 

Many individuals are ineligible to make Roth contributions due to their income being over the limit. They may make what's called a "non-deductible" contribution to a Traditional IRA (be sure to complete IRS Form 8606 notifying them that this contribution is nondeductible!) and then convert that amount to a Roth account.  

You think your tax bracket will be higher at retirement age than it is now 

If you believe your tax bracket is lower now, either due to low taxable income, or the belief that the government will raise tax rates in the future, converting your pre-tax funds to Roth may make sense. Just make sure you factor in the fact that conversions count as taxable income and could actually push you up into the next tax bracket if you're not careful. 

You don't want to have to take RMDs 

Once you hit 70 1/2, the government requires you start taking "required minimum distributions" from qualified pre-tax accounts such as 401(k)s and Traditional IRAs. If you don't think you'll need those funds and would prefer they continue to be tax-deferred, you may want to start converting your balances in advance of turning 70 1/2. 

If you'd like a little help determining if a Roth conversion is for you, or how much to convert and when, please contact me! I've helped a lot of my clients with Roth conversion strategies, and would be happy to help you as well. You can email me or call me at 360-714-3372 for a complimentary, no obligation consultation. 

Traditional IRA account owners have considerations to make before performing a Roth IRA conversion. These primarily include income tax consequences on the converted amount in the year of conversion, withdrawal limitations from a Roth IRA, and income limitations for future contributions to a Roth IRA. In addition, if you are required to take a required minimum distribution (RMD) in the year you convert, you must do so before converting to a Roth IRA.









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