What is a Roth IRA Conversion?

How do you complete a Roth IRA conversion?

A Roth conversion is when you take pre-tax retirement assets (Traditional IRA, SEP IRA, SIMPLE IRA, 457, 403b, or 401k) and convert them into after-tax Roth IRA assets. The benefit of a Roth IRA is that all future earnings are tax-free, which may provide significant long-term tax savings. Additionally, Roth IRA accounts do not have Required Minimum Distributions for the original account holder.

Is it smart to complete a Roth IRA conversion?

It depends. A common question we get from clients is whether they should complete a Roth IRA conversion.

There is no universal answer to whether you should complete a Roth conversion but here are some of the reasons a Roth conversion might be advantageous.

1. Retirement Planning
   • You want to lower your Required Minimum Distributions or avoid them altogether.
   • You expect your tax rate at the time of withdrawal in retirement to be higher than your tax rate today.
   • You currently live in a low or no-income tax state but plan to move to a state that taxes retirement distributions.
2. Estate Planning
   • You want to maximize your beneficiaries’ inheritance and expect your beneficiaries will be in a higher tax bracket at the time of inheritance than your tax bracket at the time of the conversion.
   • You want your beneficiaries to inherit your IRA funds without tax implications for them.

While there can be many reasons for completing a Roth IRA conversion, there are a few stipulations to be aware of:

1. The Five Year Rule for Withdrawing a Conversion – You must wait five tax years after any conversion before you can withdraw those assets penalty free, even if you are over 59.5.
2. Taxation – When you convert pre-tax IRA assets to a Roth IRA, you will owe ordinary income taxes (federal, state, local) on the amount of the conversion. This can result in a significant tax bill if you are converting a large balance.
   • Converting a large IRA balance in one tax year may push you into a higher tax bracket unnecessarily.
   • Converting smaller IRA balances over multiple years will incur multiple five year rules which adds complexity and potential longer periods of illiquidity without penalty.
   • In either case, you must have cash available to pay the tax bill for your Roth IRA conversion, unless you are over the age of 59.5 and plan to withdraw from your pre-tax Traditional IRA assets to pay for the tax bill.

The benefit of a Roth IRA is that all future earnings are tax-free, which may provide significant long-term tax savings. Given the tax implications associated with Roth IRA conversions, we recommend our clients consult with or have us work with their CPA or tax accountant to determine whether a Roth IRA conversion is suitable given their current and expected tax situation.

If you need assistance with a Roth IRA conversion, please contact us today to set up a free consultation. We can meet in person if you're in the area or set up a phone call or Zoom meeting if you prefer.