Is a Roth Conversion Right for Me?

August 17, 2023

Q: I’ve heard that having money in a Roth IRA for retirement is very beneficial and better than a Traditional IRA. Should I be converting my money from my Traditional IRA into a Roth account?

 

A: This question is very complex; answering it involves an in-depth analysis of your specific situation. One major reason why the Roth IRA has such a good reputation is that it provides a unique sense of psychological certainty regarding taxes. This is offered by very few forms of retirement savings.

 

Roth IRAs were created in 1997 to offer people a different kind of savings vehicle for retirement. They could pay their taxes up front, allowing their earnings to grow tax-free, and eventually enjoy tax-free withdrawals in retirement. To make it even more simple, once your money is in the account, you can forget about taxes, assuming you follow the appropriate rules for distribution. Since you’ve already paid taxes on your contributions to a Roth IRA, when you see your balance, you know what you have to work with. It’s like going to your favorite restaurant and ordering your regular dish: there is comfort in knowing what you’re going to get.

 

In most traditional forms of retirement accounts, your contributions are made pre-tax, such as in 401(k)s and traditional IRAs. However, this leads to a degree of uncertainty about which tax bracket you will be in when the money is taken out, and how that will change over time. These aspects can be relatively hard to predict, as individual situations change, and tax brackets are decided in the halls of Washington, shifting dramatically over the years.

 

Since the Roth IRA is a relatively recent invention, most retirees and senior employees have much larger balances in their traditional IRA accounts than in their Roth accounts. This is where a Roth conversion comes in. You are allowed to transfer or rollover funds from taxable forms of retirement into a Roth IRA, but it comes at a cost. You will realize that amount of taxable income in the year of conversion.

 

This brings us back to your question, are Roth accounts best? That ultimately depends on your goals and your specific situation. There is no easy guide for determining the perfect time to convert to a Roth IRA, but the following factors can help you make this decision:

 

  1. What tax bracket are you in right now? This is a relatively easy question to answer. You can look up current year tax brackets, or ask your accountant what your marginal tax rate is.

 

  1. What tax bracket do you expect to be in at retirement? This is a much harder question to answer as it relies on future tax changes. However, most people should be able to estimate this by looking at their Social Security benefits, their estimated required minimum distributions, and other income sources, like pensions or rental properties.

 

  1. Who will inherit your leftover retirement funds? It is a huge benefit for children or individual beneficiaries to receive Roth accounts, because they will not owe taxes on inherited Roth accounts. Such a gift is even more powerful if your heirs are in relatively high tax brackets themselves at the time of inheritance. However, if you lack children or individual beneficiaries, and all of your funds are going to charity, it may be better to keep the traditional accounts. Converting the account creates a tax bill for you and offers no added benefit for the receiving qualified charitable organization, as they will owe no taxes on any donations they receive.

The answers to these three major questions will give you a better sense of whether a Roth conversion makes sense for you in a given year. If all signs point towards you being at a lower tax bracket currently than you will be in retirement and you put a high value on your beneficiaries receiving after-tax dollars, then you’re probably a great candidate for a Roth conversion.

If you’re interested in an evaluation on this issue, it would be best to confer with both a financial advisor and an accountant to determine if this move aligns with your overall financial goals.


Please see important disclosure information here.´╗┐

Zach Harney, CFP®, CIMA®, AIF® is a Wealth Advisor at Monterey Private Wealth, Inc., an independent wealth management firm in Monterey. He welcomes questions you may have concerning investments, taxes, retirement, or estate planning.  Send your questions to: Zach Harney, 2340 Garden Road Suite 202, Monterey, CA 93940 or email zach@montereypw.com.