The Basics of a Roth Conversion

11/24/2023

My favorite investment vehicle is a Roth IRA. To recap, money that you contribute to a Roth IRA is taxed now, but you are never taxed on the principle or growth again. For more details, see my article here.

You may have an IRA and wish more of your retirement funds were in a Roth IRA. You may also make too much money to be eligible to contribute to a Roth IRA. This is where a Roth conversion can help.

You can convert as much as you want from your IRA to your Roth IRA. Do not rush into this decision, though, as it is not right for everyone. There are pros and cons. 

Pros:

-          You will never pay taxes on these funds or the growth of these funds again.

-          If you have non-deductible contributions in your IRA, you will not have to pay taxes on your contributions again (only the earnings). This is called the backdoor Roth IRA.

-          No worries about income tax increases affecting how much taxes are paid on distributions in the future.

-          No worries about Roth IRA distributions adding to your income and bumping you into a higher tax bracket (income can also affect other areas of your financial situation like marketplace health insurance premiums)

-          No required minimum distributions from a Roth IRA when you reach a certain age (73 for IRAs in 2023)

-          If you are at a higher tax bracket in retirement than you are now, you may be paying less in taxes on a Roth IRA conversion than if you took funds from a pre-tax account later.

-          There is no annual maximum conversion amount; you can convert as much as you would like. The deadline each year is December 31.

Cons:

-          You will pay taxes on the conversion in the tax year you make the conversion, so be prepared to pay taxes out of pocket.

-          If you are at a lower tax bracket in retirement than you are now, you will be paying less in taxes on a Roth IRA conversion than if you took funds from a pre-tax account later.

-          Income tax increases in the future could make you wish you would have done the conversion.

-          Your other existing pre-tax assets (not your 401(k)) can affect how much of your Roth conversion is taxable.

-          Lawmakers have considered in the past eliminating the backdoor Roth IRA contribution strategy, so there may be limited time to use this.

*This is meant to give a short overview of what a Roth conversion is, not every detail. Please do not use just this article to decide whether a Roth conversion is right for you. There are caveats to this depending on your situation, so please contact me if you would like to review your specific situation.