Five Things to Know About Roth Conversions

A Roth conversion moves money from a pre-tax retirement account into a Roth IRA. You pay ordinary income tax on the amount converted now, and in exchange the balance grows tax-free and comes out tax-free in retirement, with no required minimum distributions during your lifetime.

1. It is a bet on your future tax rate

Converting makes sense when the rate you pay today is lower than the rate you expect on that money later. The years between retirement and the start of Social Security and required distributions are often the lowest-bracket years of a lifetime — and the natural window for conversions. A conversion in a peak earning year usually is not.

2. Convert in slices, not all at once

The tax is calculated on the converted amount stacked on top of your other income, so a large one-time conversion can push you through several brackets. Filling the remainder of your current bracket each year, over a series of years, generally produces a far smaller total tax bill than one large conversion.

3. Pay the tax from outside the account

Using taxable savings to pay the tax leaves the full converted balance compounding tax-free. Withholding the tax from the conversion itself shrinks the amount that gets the Roth benefit — and, before age 59½, the withheld portion can be treated as a distribution subject to penalty.

4. Watch the effects that are not income tax

Conversion income can raise Medicare Part B and Part D premiums two years later, increase the taxable share of Social Security benefits, and affect income-based credits. None of these are reasons to avoid converting; they are reasons to size the conversion deliberately.

5. Remember the beneficiaries

Most non-spouse heirs must empty an inherited retirement account within ten years. Inheriting a traditional IRA can mean ten years of taxable distributions landing in a beneficiary's peak earning years; inheriting a Roth generally does not create that bill. If leaving assets to children is part of your plan, their brackets belong in the analysis alongside yours.

How to decide

Model it. Compare the tax cost of converting a specific amount this year against the projected tax on that same money later, including Medicare surcharges and the tax your heirs would owe. Conversions are one of the few planning moves where the arithmetic gives a fairly clear answer.

This article is educational and is not individual tax advice. Conversions cannot be undone, so confirm the numbers with your tax professional before you convert.

Common questions

Can a conversion be reversed?

No. Recharacterizing a conversion is no longer permitted, which is why sizing it correctly before year-end matters so much.

Is there an income limit to convert?

No. Roth contributions are income-limited, but conversions are not — anyone with a pre-tax retirement account can convert.

When is the best time of year to convert?

Late in the year, when your income for the year is nearly known, so the conversion can be sized to fill a bracket precisely rather than estimated in January.

Sources

• IRS — Roth IRAs
• IRS — FAQs on Rollovers and Roth Conversions
• IRS Publication 590-A — Contributions to IRAs