Is a Roth Conversion a Good Idea?


If you have any type of retirement account, there’s a good chance you’ve heard of a Roth IRA. You may have also heard of a concept called a Roth Conversion. There are many potential benefits to a Roth Conversion, however, before you take the leap, you must have all the information. In this article, we’ve compiled the details you need to know about Roth Conversions, from what they are to how they work.

What is a Roth Conversion and How Does it Work?

Roth conversions occur when funds are transferred from a traditional pre-tax retirement account to an after-tax Roth account. There are several types of Roth conversions:

  • Transfer money from a traditional IRA into a Roth IRA.

  • Roll over a 401(k) to a Roth IRA.

  • Carry money from a standard 401(k) account to a Roth 401(k) account.

  • Use a backdoor Roth IRA strategy.

Assuming your regular retirement plan contributions were deductible—that is, paid out of your paycheck before taxes or IRA contributions deducted from your taxes—you would owe income tax upon each dollar you transfer to a Roth account. The tax is assessed in the year you make the transition. A significant conversion in a single tax year may push you into a higher tax rate or have additional consequences.

It is unnecessary to convert the whole amount of a traditional retirement plan to a Roth account all at once; you can conduct partial conversions anytime you wish. To minimize the impact on your taxes and other advantages, spread several conversions of a significant sum over multiple years.

The Five-Year Rule

The IRS imposes a 10% penalty on any withdrawals from a converted Roth IRA within the first five years. However, if you decide to seek many Roth conversions over the course of several years, you must be aware that every Roth conversion has its own five-year clock. If you wanted to switch a 401(k) balance to a Roth IRA in 2022, 2023, or 2024, you'd have to follow three separate five-year requirements. The clock for the five-year rule begins on January 1 of the year you convert. So, if you converted funds in December 2022, the IRS deems your five-year clock to have begun on January 1, 2022. For that December conversion, you'd effectively have only four years until you could touch the money.

Benefits of Roth Conversions

  • Growth and withdrawals are tax-free. Once the conversion tax is paid, there will be no more tax due on the money in a Roth account while it accumulates, and no tax when you withdraw (after following the five-year rule and attaining the age of 59 1/2 or another preapproved exemption).

  • Reduce your RMDs. Roth IRAs do not have any mandatory minimum distributions. Remember that RMDs apply to Roth 401(k)s as well. Even if you simply convert a portion of your traditional account balances, the smaller balances remaining in traditional accounts entail lower yearly RMDs when you reach the age of 72.

  • Diversification of taxes. Suppose you presently have all of your retirement savings in traditional accounts, transferring a part to a Roth account. In that case, you might find things simpler to pay for large-ticket expenses without increasing your taxable income. Whether it's for a new roof or a multigenerational vacation to commemorate a milestone birthday or anniversary, withdrawing additional funds from a traditional account over your RMD can boost your taxable income for the year. There is no tax due if you withdraw funds from a Roth IRA (just keep an eye on that five-year rule).

  • There will be no tax issues for heirs. Suppose you want to leave an account to a non-spouse beneficiary. In that case, new laws that entered into effect in 2020 require non-spouse beneficiaries to empty an inherited IRA within ten years. If a non-spouse recipient inherits a Roth IRA, they must still withdraw the whole amount by the end of the ten years, but they will not be taxed.

When Does it Make Sense to do a Roth Conversion?

The ability to make tax-free withdrawals in retirement is a significant benefit of Roth IRA conversions. This might be enticing if you plan to be in a larger marginal tax bracket in retirement, which most individuals do not. However, there is another component of conversions that receives less emphasis. The amount of taxes paid for such conversions would be decreased if you timed a series of conversions to coincide with years when your tax rate is lower. The secret to a Roth IRA conversion is to manage the tax considerations. It makes little sense to convert if you would be hit with a tax bill that is significantly higher than if you had waited to remove the assets. Another consideration is that you don't want a substantial conversion in one year to push you into a higher tax bracket.

Should You Do a Roth Conversion?

If you presently have a big portion of your retirement funds in traditional retirement plans, a Roth conversion may be a wise strategy to control your tax cost in retirement. It can also assist possible heirs in managing their tax liability. However, because the money you convert is recorded as taxable income, it necessitates a cautious strategy that does not result in a large tax burden in any particular year. It's probably a good idea to set an appointment with us here at Fourth Avenue Financial LLC, where we can assist you and help you understand all of the moving parts of a Roth conversion.

Schedule A Consultation with an Experienced Financial Advisor

Here at Fourth Avenue Financial, our first priority is your overall financial success. We want to help you develop, implement, and monitor a strategy designed to address your individual situation to ensure all your investments are setting you up for a path of financial success. If you are ready to start planning for your financial future, we are here to help. Contact us today at (304) 746 7977 to schedule a meeting with one of our experienced financial advisors or schedule online: https://calendly.com/fourthavenuefinancial/introductory-zoom.


Securities are offered through J.W. Cole Financial, Inc. (JWC) Member FINRA / SIPC. Advisory Services are offered through J.W. Cole Advisors, Inc. (JWCA). Fourth Avenue Financial and JWC/ JWCA are unaffiliated entities.


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