Maximizing Your Retirement: The Power of Roth Conversions

Monday, February 10th, 2025

Presented by Sean P. Reilly, CFP®, CPWA®, CIMA®, CEPA®, Managing Director

When it comes to retirement planning, most people are familiar with the concept of traditional IRAs, 401(k)s, and Roth IRAs. But there’s one strategy that doesn’t get nearly enough attention: Roth conversions. A Roth conversion allows you to convert money from a traditional IRA or 401(k) into a Roth IRA. While it might sound complicated, it could be one of the most beneficial financial moves you can make to maximize your retirement income.

What is a Roth Conversion?

A Roth conversion involves transferring funds from a tax-deferred retirement account (like a traditional IRA or 401(k)) to a Roth IRA. This move can be particularly useful if you anticipate being in a higher tax bracket during retirement or if you want to minimize taxes on your future withdrawals.

Here's the key difference: Traditional IRAs and 401(k)s are funded with pre-tax dollars, meaning you don't pay taxes on that money until you withdraw it in retirement. On the other hand, Roth IRAs are funded with post-tax dollars, so you pay taxes up front, but once the money is in the account, it grows tax-free and you can make tax-free withdrawals during retirement.

When you perform a Roth conversion, the amount you convert from the traditional IRA to the Roth IRA is taxed as ordinary income for the year of the conversion. This is the catch: you pay taxes on the converted amount now, but then the money grows tax-free in the Roth IRA.

Why Consider a Roth Conversion?

There are several reasons why a Roth conversion might make sense for you:

1. Tax-Free Withdrawals in Retirement
One of the biggest benefits of Roth IRAs is that you can take tax-free withdrawals in retirement, which is not the case with traditional IRAs or 401(k)s. By converting funds to a Roth IRA now, you pay taxes upfront at today’s tax rates, and you avoid paying taxes on those funds in the future.

2. No Required Minimum Distributions (RMDs)
Traditional IRAs and 401(k)s require you to start taking required minimum distributions (RMDs) at age 73. These withdrawals are taxed as ordinary income, which can be a burden in retirement. Roth IRAs, however, do not require RMDs, so your funds can continue to grow tax-free for as long as you want.

3. Strategic Tax Planning
A Roth conversion can be a powerful tool for managing your tax liability in retirement. If you expect your income to be lower now than it will be in retirement, it may make sense to convert some of your traditional IRA funds to a Roth IRA while you’re in a lower tax bracket. This way, you’re locking in a lower tax rate on the converted amount.

4. Avoiding Higher Taxes in Retirement
If you anticipate that tax rates will rise in the future, converting to a Roth IRA now can be an effective hedge against future tax increases. By paying taxes now, you avoid potentially paying higher taxes later on your retirement withdrawals.

5. Estate Planning
Roth IRAs can be a useful tool in estate planning. Because Roth IRAs don’t have RMDs, the account can grow for your heirs, and they can take tax-free withdrawals. This is an attractive feature if you're looking to leave a tax-efficient legacy to your loved ones.

Things to Consider Before Doing a Roth Conversion

Although Roth conversions can be highly beneficial, they are not for everyone. Here are some factors to keep in mind before making the conversion:

1. Tax Implications
When you convert from a traditional IRA to a Roth IRA, the amount converted is treated as taxable income. If you convert a large amount in one year, you could bump yourself into a higher tax bracket, resulting in a hefty tax bill. It’s important to work with a financial advisor to determine how much to convert at once to avoid an unwelcome tax surprise.

2. Paying Taxes on Converted Funds
Since you pay taxes on the converted funds upfront, you'll need to have the cash available to cover the tax bill. If you use the Roth IRA funds themselves to pay for the taxes, you may incur penalties and miss out on the tax-free growth of those funds.

3. Current Tax Bracket
If you’re already in a higher tax bracket, it may not make sense to convert a large portion of your traditional IRA to a Roth IRA. If you’re in a lower tax bracket now, however, a Roth conversion might make more sense since you’ll pay less in taxes on the conversion.

4. The Five-Year Rule
One important rule with Roth conversions is the five-year rule. If you convert funds to a Roth IRA, you must wait five years before you can withdraw the converted funds tax-free. While your gains in the Roth IRA will be tax-free once you're 59½, you'll still need to wait for the five-year period to expire to avoid penalties on the converted amounts.

5. Impact on Medicare and Social Security Taxes
Converting a large amount of money could affect your income level, which in turn could increase your Medicare premiums or result in higher taxation of your Social Security benefits. Be sure to consider how a Roth conversion might impact these aspects of your retirement.

How to Execute a Roth Conversion

Executing a Roth conversion is relatively simple. Here are the basic steps:

1. Evaluate Your Retirement Accounts: Take a look at the balance in your traditional IRA or 401(k) and determine how much you want to convert to a Roth IRA.

2. Consult a Financial Advisor: It’s a good idea to work with a tax professional or financial planner to assess your tax situation and determine the optimal amount to convert, especially if you’re converting large sums.

3. Open a Roth IRA: If you don’t already have a Roth IRA, you’ll need to open one to facilitate the conversion.

4. Initiate the Conversion: You can request the conversion from your current IRA custodian. The process is usually straightforward and can be done online or via a paper form.

5. Pay Taxes on the Conversion: When you file your taxes for the year, you’ll report the conversion amount as taxable income. Be prepared to pay taxes on that amount when you file your return.

Conclusion

Roth conversions can be an extremely effective strategy for retirement planning, but they’re not a one-size-fits-all solution. They come with immediate tax consequences, and the best time to execute one depends on your current and future financial situation. By converting to a Roth IRA, you’re setting yourself up for potentially tax-free growth in retirement and greater flexibility in managing your withdrawals.

If you’re considering a Roth conversion, make sure to work with a financial advisor to ensure that you’re making the best decision for your long-term retirement goals. With careful planning, a Roth conversion could be the key to a more tax-efficient and financially secure retirement.