Roth Conversion (Roth IRA Conversion)

A Roth conversion is a strategic tax move where you voluntarily pay taxes today on pre-tax retirement savings to gain tax-free status forever. It's essentially pre-paying your retirement taxes at today's (hopefully lower) tax rates.

How It Works:

Traditional IRA/401(k):

• Contributions are pre-tax (tax deduction now)
• Growth is tax-deferred
• Withdrawals taxed as ordinary income in retirement
• Required Minimum Distributions (RMDs) at age 73

After Roth Conversion:

• Pay taxes on converted amount in year of conversion
• All future growth is tax-free
• Withdrawals are 100% tax-free in retirement
• No RMDs ever (in your lifetime)

Example: You have $100,000 in Traditional IRA, in 24% tax bracket

Convert to Roth:

• Taxes owed: $100,000 × 24% = $24,000
• After-tax Roth IRA balance: $100,000 (you pay taxes from other funds)
• Future growth: Tax-free forever
• RMDs: None

When Roth Conversions Make Sense:

1. Low-Income Years ✅ Retired early (before Social Security/pension starts) ✅ Career gap, sabbatical, maternity leave ✅ Business loss year ✅ Recent retirement (before RMDs kick in)

Example:

• Normal income: $150,000 (24% bracket)
• Early retirement year: $40,000 (12% bracket)
• Convert $60,000 at 12% tax rate = $7,200 tax
• vs waiting until 24% bracket = $14,400 tax
• Savings: $7,200

2. Expecting Higher Tax Rates in Future ✅ Currently in low bracket, expect to be in higher bracket in retirement ✅ Belief that tax rates will increase legislatively ✅ Large traditional IRA will force high RMDs later

3. Estate Planning ✅ Want to leave tax-free Roth IRA to heirs ✅ Heirs in high tax brackets (better for them to inherit Roth) ✅ Reduce taxable estate (pay taxes now, less for heirs later)

4. Avoid RMDs ✅ Don't need RMD money for living expenses ✅ RMDs push you into higher tax bracket ✅ RMDs trigger Medicare IRMAA surcharges

5. Tax Diversification ✅ All savings in traditional 401(k)/IRA ✅ Want mix of taxable, tax-free, and tax-deferred accounts ✅ Flexibility to manage retirement tax bracket

Roth Conversion Strategies:

Strategy 1: Fill Up Tax Bracket Convert just enough to stay in your current bracket

Example (Married Filing Jointly, 2024):

• Current income: $70,000
• 12% bracket ends at: $94,300
• Available room: $24,300
• Convert $24,300 at 12% tax rate = $2,916 tax
• Avoids jumping to 22% bracket

Strategy 2: Partial Conversions Over Multiple Years Spread large conversions across low-income years to avoid bracket creep

Example:

• Traditional IRA: $500,000
• Convert $50,000/year for 10 years
• Stay in 22% bracket vs jumping to 32% with one-time conversion

Strategy 3: Convert in Early Retirement (Ages 60-72) Sweet spot between retirement and RMDs

Timeline:

• Age 60-62: Retire, low income
• Age 62-70: Delay Social Security
• Convert Traditional IRA to Roth during these years
• Age 73: RMDs start (but your IRA is now Roth, no RMDs!)

Strategy 4: Back-Door Roth (for High Earners) If income too high for direct Roth contributions:

1. Contribute to non-deductible Traditional IRA
2. Immediately convert to Roth
3. Pay taxes only on growth (minimal if immediate)

Strategy 5: Roth Conversion Ladder (Early Retirement) For retiring before 59½:

1. Convert Traditional to Roth
2. Wait 5 years
3. Withdraw converted principal penalty-free
4. Access retirement funds before 59½ without penalty

Tax Implications:

Taxes Owed: Converted amount is added to taxable income for the year

Example:

• Salary: $80,000
• Convert: $40,000
• Total taxable income: $120,000
• Extra tax on conversion: ~$8,800 (22% bracket)

No Penalty:

• No 10% early withdrawal penalty on conversions (at any age)
• BUT must wait 5 years to withdraw converted principal or face penalty

Can't Undo:

• Before 2018: Could "recharacterize" (undo) conversion
• After 2018: Roth conversions are permanent
• Choose conversion amount carefully!

5-Year Rule: Each conversion starts its own 5-year clock:

• Convert in 2024 → can withdraw penalty-free in 2029
• Convert in 2025 → can withdraw penalty-free in 2030

Mistakes to Avoid:

❌ Converting too much: Pushes you into higher tax bracket ❌ Paying taxes from IRA: Reduces conversion benefit (pay from other funds) ❌ Converting right before RMD: Must take RMD first (can't convert RMD) ❌ Not considering Medicare: Can trigger IRMAA surcharges (higher Part B/D premiums) ❌ Ignoring state taxes: Some states tax conversions even if no income tax on retirement

Roth Conversion Impact on Medicare:

Large conversions can push income above IRMAA thresholds:

Example: Convert $80,000, pushes income to $135,000 → pay extra $2,096/year in Medicare premiums for 2 years

Who Should NOT Do Roth Conversions:

❌ Expect to be in lower tax bracket in retirement ❌ Need IRA funds for current expenses (can't afford tax bill) ❌ Over age 70 with limited life expectancy (not enough time to benefit) ❌ In peak earning years (high tax bracket) ❌ State has high income tax now, plan to retire in no-tax state

The Math:

Roth conversion wins if: Tax rate at conversion < Tax rate at withdrawal

Example:

• Convert at 12% tax rate (low income year)
• Would have withdrawn at 24% in retirement
• Roth conversion saves 12% on entire balance + growth

The Bottom Line: Roth conversions are powerful for those in low-income years or expecting higher future tax rates. The key is timing conversions during your lowest tax years and avoiding bracket creep. Consult a tax professional before large conversions.