When most people think about retirement, they focus on how much they’ve saved. But there’s another important question that’s often overlooked:
How much of your retirement savings actually belongs to you—and how much belongs to the IRS?
Nobody enjoys paying taxes but a key point today is that for most taxpayers, tax rates are generally at the lowest level since the 1950’s. Paying today versus paying later could save you and your beneficiaries from paying far more than necessary.
If a large portion of your retirement money is sitting in a traditional IRA, 401(k), or 403(b), every withdrawal you make in retirement could be subject to income taxes. That’s where a Roth conversion can become an attractive planning strategy.
What Is a Roth Conversion?
A Roth conversion simply means moving money from a traditional IRA into a Roth IRA. The amount you convert is taxable as ordinary income in the year of the conversion, but once the money is inside the Roth IRA, it has the potential to grow tax-free. Even better, qualified withdrawals in retirement are generally tax-free as well.
Think of it like paying the tax bill upfront instead of later.
Why Would Someone Convert?
People choose Roth conversions for many different reasons.
Some believe tax rates will be higher in the future and would rather pay taxes at today’s rates. Others want to protect their spouse and children from continuing to pay taxes on those inherited IRA funds. This is a tax that never goes away.
A Roth IRA also isn’t subject to required minimum distributions during the owner’s lifetime, giving retirees greater control over when—or if—they withdraw their money.
Is It Right for Everyone?
Not necessarily.
A Roth conversion can make sense if you’re currently in a relatively low tax bracket or if you have several years before retirement to allow the converted money to grow.
On the other hand, converting a large amount all at once could push you into a higher tax bracket, increase Medicare premiums, or affect the taxation of Social Security benefits. That’s why many people choose to convert smaller amounts over several years instead of everything at once.
Planning Is the Key
A successful Roth conversion isn’t just about moving money—it’s about timing and recapturing those taxes paid.
Questions to consider include:
- What tax bracket are you in today?
- What tax bracket do you expect in retirement?
- Can you pay the taxes from savings outside your IRA?
- How quickly can you recapture the taxes paid at conversion?
- How will the conversion affect other areas of your financial life?
Working through these questions can help determine whether a Roth conversion fits into your overall retirement strategy.
The Bottom Line
A Roth conversion isn’t about avoiding taxes—it’s about choosing when you pay them. For many retirees and pre-retirees, paying some taxes today may create greater tax flexibility and peace of mind in the future.
Every financial situation is unique, so before making a Roth conversion, it’s wise to review the numbers with a financial advisor and a qualified tax professional. With thoughtful planning, a Roth conversion can divorce those retirement plans from ongoing taxation for you and your future generations.
The opinions expressed represent those of Freshour Financial, LLC and are subject to change without notice. It is provided for informational purposes only, and nothing herein constitutes investment, legal, accounting, or tax advice, nor a recommendation to buy, sell, or hold any security. We strongly recommend consulting a financial adviser before making any investment decisions to determine suitability for your specific needs.
Advisory Services of Freshour Financial, LLC are offered through Compass Financial Management, an SEC Registered Investment Advisory.
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