Benefits of a Roth Conversion

With Americans living, on average, longer than before and the strength of Social Security and pension programs on the decline—securing enough income to maintain quality of life throughout retirement can be complicated. With tax rates likely to increase for certain groups in the future, now may be a good time to consider a Roth IRA conversion. The more you have managed to save in a traditional IRA or 401(k), the more a Roth conversion may be a smart and efficient way to protect and grow your assets for later use in retirement.

There are a few key advantages to a Roth account, particularly as a tool to manage the tax burden and required minimum distributions (RMDs) that are attached to traditional IRAs and 401(k) plans once your reach the age of 72. With a Roth conversion, the income tax payment is paid upfront on the amount you convert—whether it be transferring money from a traditional IRA into a Roth, rolling over a 401(k) into a Roth IRA, or moving money from a traditional 401(k) into a Roth 401(k)—but the money can grow and be taken out in retirement tax free and in the case of ROTH IRAs, without any RMDs.

Important to note that there is a five-year rule attached to Roth conversions, meaning every time you move money into a Roth account, there is a 10% penalty for withdrawals on that money within five years. But for retirement investors who don’t need immediate access to that money and are not yet taking Social Security benefits, a Roth conversion can be a great hedge against rising tax rates, a way to mitigate the amount of RMDs, provide long-term tax diversification, and leave beneficiaries with a tax free vehicle to inherit your money.

There is usually a dramatic uptick of people wanting to make a Roth conversion during sharp market declines, like Q4 2018 or March of 2020, to take advantage of the lower tax rates and allow the money to grow back over time in a Roth. For individuals with large 401(k)s, 403(b)s, or traditional IRAs, converting to a Roth to mitigate the high RMDs in retirement can be very attractive.

A Roth 401(k) can be a useful vehicle for tax diversity as well, particularly for individuals who are still working in later years and do not yet need retirement income to live off of. A conversion of money from a traditional retirement account to a Roth 401(k) can help to maintain a lower tax bracket while offering tax free growth of assets without the income restraints that may be attached to a Roth IRA contribution.

Roth conversions aren’t right for everyone. Paying contribution taxes up front, complications in the timing and taxation of Social Security benefits, and potentially raising Medicare Part B and D premiums may mean that a Roth conversion will carry tax disadvantages for your situation. For others, if timed and applied correctly, a Roth conversion can provide the ability to control taxable distribution throughout retirement, better manage Medicare premium costs and their effect on Social Security, and offer the freedom to choose when and how much money to distribute—making them one of the most versatile and useful income vehicles for retirees.

Please contact the Sapers & Wallack financial planning department and we will be happy to run the analysis for you to find out if the Roth conversion is right for you.

Sapers & Wallack does not provide tax advice. For complete details, consult with your tax advisor as well.