Should I Convert to Roth?

  • Home
  • Should I Convert to Roth?

Thinking of your retirement often brings to mind joyful days with grandchildren, the pursuit of long-held hobbies, and perhaps some well-deserved travel. But among these pleasant thoughts, there may be a less welcome guest: the prospect of handing over a substantial portion of your savings to Uncle Sam—possibly as much as 37%! After years of paying taxes, you might wonder, isn’t it time for a break from filling the seemingly endless coffers of the US government?

Unfortunately, many Americans don’t factor in taxes when heading into retirement. They hold the mistaken belief that either they won’t owe any taxes on their 401(K) or IRA contributions or they won’t owe that much. To their surprise, not only do they owe taxes on their contributions but also taxes on the possibly decades of compound growth. And those with a sizeable retirement income could be paying up to a 37% tax rate (the current highest rate on taxable income).

However, it doesn’t have to be that way. 

They say the only two things that are guaranteed are taxes and death. Well, let’s adjust that a bit – it is possible to have a tax-free retirement, at least when it comes to your savings parked away in a specific, tax-advantaged retirement plan. 

And that plan is the Roth

When you contribute to your retirement plan, you generally have two choices: traditional or Roth. 

Traditional contributions are tax-deferred, meaning your contribution is deducted from your taxable income, reducing your taxable income for the year and possibly even keeping you in a lower tax bracket. 

With Roth contributions, you first pay taxes on your income and then contribute to your Roth account, be it an IRA or 401(K). Then, the earnings on your contributions are tax-free as long as you follow Roth withdrawal rules: 

  • Must be at least 59.5. 
  • The contribution must have been made at least five years prior.

As a benefit to paying your taxes early and following withdrawal rules, you get the following: 

  • Tax-Free Growth
  • Tax-Free Withdrawals
  • No Required Minimum Withdrawals
  • Tax-Free Legacy for Beneficiaries 

Roth Contributions and Conversions

If all of your contributions have been Traditional and you’d like to take advantage of the Roth, you’re not out of luck. You have two options:

  1. Begin making Roth contributions rather than Traditional contributions.
  2. Convert existing Traditional contributions to Roth contributions.

This article will examine the second option: converting your existing, tax-deferred savings into post-tax Roth savings.

Should You Convert To Roth?

Of course, this is a complex issue. Before we get into rudimentary scenarios, we highly recommend sitting down with a financial advisor to determine if a conversion is right for you. A conversion has significant implications on your taxes and the immediate size of your savings that could significantly impact your retirement planning in unexpected ways. 

How Old Are You?

One of the most significant factors is your age. If you are close to retirement and will need your savings within a few years, converting to a Roth may not be a good idea, as you’ll have to wait five years to touch your funds to avoid penalties. However, the further away from retirement you are, the more sense it generally makes to convert. 

What’s Your Tax Rate?

What’s your tax rate now? More importantly, what will your tax rate be in the future? If you foresee being in a higher tax bracket in retirement, you may want to get taxes out of the way while in a lower tax bracket. Some investors mistakenly assume that they’ll be in a lower tax bracket in retirement but don’t consider sources of income that often appear later in life – Social Security, pensions, inheritances, or rental income, just to name a few. 

Also, we never know what taxes will be like in the future – the highest rate today is 37%, but history shows that they can be much higher. Getting taxes out of the way at a known tax rate rather than risk an unknown rate later is easier for many Americans. 

How Will a Conversion Affect Your Tax Bill?

This is tied in with your tax rate. If you’re in a lower tax bracket than usual, it may make sense to convert to Roth. But you have to consider your tax bill, as you’ll owe taxes on any converted funds, which means you’ll need a plan to pay for that tax bill. 

In our next article, we’ll go into the various ways to pay for it, but for now, keep in mind that you’re likely to owe a sizeable sum of money to the IRS.

Would You Like to Reduce Your Taxable Income in Retirement?

Withdrawals from traditional IRAs or 401(K)s are not only taxable but also increase your overall taxable income, potentially pushing you up a tax bracket and affecting your Medicare premiums and Social Security taxation. Eventually, you’ll be forced to withdraw from your traditional IRA or 401(K) in the form of a Required Minimum Distribution (RMD), potentially negatively affecting your tax plan. 

Roth withdrawals don’t come with any extra tax baggage or RMDs – as long as you comply with Roth regulations, you won’t see any difference in your benefits, premiums, or tax brackets.

Final Thoughts

It’s difficult to beat the benefits of the Roth – tax-free withdrawals, zero impact on your income bracket, Social Security benefits and Medicare premiums, flexible withdrawal planning, no RMDs, and the ability to pass on a tax-free account to beneficiaries all come together to form a potent retirement and estate planning tool. However, it may not make sense to convert your traditional savings into Roth savings – at least right now. You may be in a higher-than-normal tax bracket, unable to pay the resulting tax bill, or simply too close to retirement for a conversion to be feasible, among other factors. 

If you’d like to sit down with a professional financial advisor who can help you determine the best path for your funds, click the button below!

You are leaving this website.

Before you proceed, we would like to alert you that you are navigating away from this website to access another website that offers fixed insurance and brand marketing.


Financial Planning