To convert or not to convert?

Your Roth options at a glance

Let’s look at the pros and cons of a Roth conversion to see if it is right for you.

Roth accounts are a great vehicle if you’re looking for ways to allow your money to grow tax-free and make withdrawals in retirement without paying additional taxes. If you haven’t been contributing to a Roth, a conversion might make sense for you. However, there are some important consequences of a Roth conversion to be considered before you make this change.

The basics

A Roth account is funded with after-tax dollars, meaning you pay taxes on the funds before contributing and do not take a tax deduction. With a traditional IRA, you take a tax deduction when contributing the funds and pay taxes on the distribution. Roth accounts grow tax-free, and you can withdraw qualified funds tax-free. If you have been contributing to a Traditional IRA, you can convert the funds to a Roth IRA. This includes contributions to Traditional IRAs, SEP IRAs, and Simple IRAs.

The downside

When you convert pre-tax money in a regular IRA to a Roth IRA, this money is treated as regular income, and you pay taxes on it at your current rate. The conversion amount is treated as regular income, which can bump you into a higher tax bracket and cause a high tax bill for the conversion year.

A Roth account must be open for five years to avoid paying taxes on withdrawals. After age 59 ½, withdrawals aren’t subject to a 10% penalty, but if you haven’t had the account open for five years, the income taxes are still due.

Do you expect to be in a higher or lower tax bracket in retirement? If you expect to be in a lower tax bracket, it might not make sense to convert to a Roth IRA. But if you’re looking to have tax-free income in retirement, this could be a good option.

Finally, the process of converting a regular IRA to a Roth IRA can’t be undone. It’s important to consider your post-retirement income and other factors before making the decision to convert.

The upside

Roth IRA conversions can be worth it for a couple of reasons, despite the tax bill. If you have a high income and want to reduce your tax basis in retirement a Roth IRA can help by getting around the income caps that limit Roth contributions for higher-income taxpayers. Most taxpayers can contribute up to $7,000 (in 2024), plus another $1,000 if you are age 50. But contribution limits are lower for high-income taxpayers, and after a point, no Roth contributions are allowed at all. There are no income limitations on conversions, which is why a high-income earner might see a benefit in converting a Traditional IRA to a Roth IRA.

Required Minimum Distributions (RMDs) are not required for Roth IRAs. These mandatory withdrawals from retirement accounts begin at age 73 and can create a tax burden on high-net-worth retirees. But Roth owners are not required to take RMDs for as long as they live, which makes Roth IRAs particularly useful for leaving inheritances.

Let’s talk

If you think a Roth conversion might be right for you, Scarborough Alliance can help. Together we can run the numbers and discuss how a conversion would affect your situation.