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Is A Roth Conversion Right for You? 3 Telltale Signs It's A Yes

In retirement, money isn’t simply money. Where it’s stored has a significant impact on how you can use it and what it will cost you to do so. $1,000 looks vastly different in a traditional IRA than it does a Roth IRA. 



Proactive tax planning is critical for your retirement wealth-building strategy because it saves you money and helps preserve the longevity of your nest egg. Today, we’re diving into a strategy that can prove instrumental in your retirement income plan—Roth conversions. 

What’s a Roth conversion and how will you know if it’s right for you?

The impact of taxes on retirement income

Before exploring the ins and outs of Roth conversions, it’s critical to understand the value tax planning plays in your retirement strategy. Without proper planning, taxes can eat up more net gains than many retirees anticipate. 

Each retirement account comes with different tax rules and regulations. A traditional IRA, for example, is tax-deferred, allowing pre-tax contributions (up to certain income thresholds) and taxable distributions. If you’re in the 24% tax bracket and withdraw $1,000 from a traditional IRA, the balance shrinks to $760. 

Now, say that $1,000 lived in a Roth IRA. You made after-tax contributions and now want to make a qualified distribution. In this case, the $1,000 retains its full value. Since you paid taxes when you contributed to the account, you don’t have to pay taxes for qualified distributions. 

Retaining a mix of tax-deferred (traditional IRA), taxable (brokerage accounts), and tax-exempt (Roth IRA) retirement accounts amplifies your tax-diversity, giving you a wide array of options for distributions in retirement. For many retirees, Roth dollars can maximize flexibility and freedom. 

If your Roth accounts are a little light or if you make too much to directly contribute to them, consider a Roth conversion.

What’s a Roth conversion?

A Roth conversion allows investors to change all or part of their traditional accounts (401k or IRA) into a Roth IRA. 

Why convert funds as opposed to contributing directly? 

Roth IRAs carry income limits, which can bar higher-earning professionals from direct contributions. In 2021, phaseouts begin at $198,000 for married couples filing jointly and end completely if combined income meets or exceeds $208,000.

A Roth conversion provides an opportunity for higher-earning investors to take advantage of Roth tax treatments. 

Another plus? Conversions aren’t subject to Roth IRA contribution limits. In 2021, you can directly contribute $6,000 (with an extra $1,000 in catch-up contributions), but you can convert well above that limit. 

Say you have an old 401k from a previous employer. If you wanted, you could convert the entire balance! With a Roth conversion, you can convert more money at a time (assuming you have the cash to pay the tax bill). 

How does this strategy impact your retirement plan?

It’s valuable to limit your tax liability in retirement to keep more of your money working to enhance your and your spouse’s ideal retirement life. Making the most of Roth dollars can help achieve that goal. 

A Roth IRA is beneficial in several ways:

  • Qualified distributions are tax-free, providing more flexibility in how/when you withdraw funds.
  • Roth IRAs don’t have required minimum distributions (RMDs). This means that you can use the money when it’s best for you, not when the government tells you to. 
  • They can be excellent (and tax-efficient) estate planning vehicles for passing wealth to heirs.

Roth conversion rules

It’s not all tax-free money and retirement bliss; Roth conversions come with specific rules and consequences to keep in mind. 

  • Decide how much you want to convert.
  • Initiate the conversion with an existing or new custodian.
  • Pay taxes on the conversion.

It’s a pretty simple three-step process, but the most important part is planning for the last step—paying taxes on the conversion. The conversion is taxed as income, which will increase your tax rate just like a bonus or extra paycheck would. It’s prudent to have the cash on hand to pay for the larger tax bill. 

Since an inflated tax payment is on the line, it doesn’t always make sense to initiate a conversion. However, there are several circumstances when the added tax liability upfront will pay immense dividends in the long run. 

Three moments to consider a Roth conversion

When done appropriately, Roth conversions can catalyze your retirement savings, save on taxes in the long-term, and improve your net gains. Let’s take a look at a few times when this strategy could benefit you. 

You’ve had a low-income year

Roth conversions are all about playing the tax game. At Step by Step, we’re passionate about the role that taxes play in your entire financial picture and want to help you capitalize on critical opportunities throughout your journey. 

Lower-income years are ripe with opportunities for Roth conversions. Say, for example, you’re normally in the 32% tax bracket but had a lower-income year that dropped you to the 24% bracket. This presents an opportunity to convert funds at a lower tax bracket—reducing your overall tax liability.

The solvency of Roth conversions is all about managing your tax bracket now and in the future. Roths are more lucrative, in general, when you’re in lower tax brackets as opposed to higher ones.

You’re retired and not collecting Social Security

Social Security is a significant component of your income plan—replacing about 40% of your income. But, that income is likely taxable. If you’re delaying Social Security, your tax bracket could be lower and might prove beneficial conditions for a Roth conversion.  

You have passive investment losses

There are several ways to make the most of an income or investment loss. If you’ve had passive losses accumulate over the years like with a rental property, for example, you could offset those losses with a Roth conversion. 

Take advantage of present tax brackets

There’s much talk in Washington D.C about increasing income tax brackets. Should that be the case, you could make the most of your current tax bracket and initiate a conversion. 

Step by Step helps you take advantage of financial opportunities

Life (and finances) are full of opportunities. It’s important to take advantage of key moments when they cross your path—it’s our joy to help you identify these areas of opportunity and make the most of them. 

For you, it could be a Roth conversion. If you’d like to talk more about how a Roth conversion could impact your financial plan, set up a call with our team today.