Roth Conversions in Retirement

Authored by Taylor Warren, CFP®

Roth IRA Conversions in Retirement: Your Comprehensive Guide

Picture this: you’re enjoying your golden years—traveling, spending time with loved ones, and not stressing about taxes on your retirement income. Sounds appealing, doesn’t it? A Roth IRA conversion could turn that vision into reality. By strategically moving money from your traditional retirement accounts to a Roth IRA at the right time, you might reduce your tax burden in retirement and even leave a tax-free legacy for your heirs. In this detailed guide, we’ll walk you through everything you need to know about Roth IRA conversions, from the basics to advanced strategies, so you can decide if this powerful tool fits your retirement plan.

What is a Roth Conversion?

A Roth conversion is the process of transferring funds from a traditional retirement account, such as a traditional IRA or a 401(k), into a Roth IRA. Here’s the catch: you’ll need to pay income taxes on the amount you convert at your current tax rate in the year the conversion is completed. The reward? Once the money is in the Roth IRA, it grows tax-free, and you can withdraw it tax-free in retirement, provided you meet certain conditions. This shift can be a game-changer, offering tax-free income when you need it most.

Who Can Do a Roth Conversion?

Good news: almost anyone with a traditional IRA or a qualified retirement plan, like a 401(k), can perform a Roth conversion. In the past, income limits restricted high earners from converting, but those barriers were lifted in 2010. Whether you’re still working, nearing retirement, or already retired, if you have an eligible retirement account, a Roth conversion is an option worth exploring.

The Pros and Cons of a Roth Conversion

Like any financial move, Roth conversions have upsides and downsides. Here’s a breakdown:

Pros:

• Tax-free growth and withdrawals: Your money grows tax-free, and qualified withdrawals in retirement are tax-free.
• No required minimum distributions (RMDs): Unlike traditional IRAs, Roth IRAs don’t force you to withdraw funds at a certain age, letting your savings grow longer.
• Potential tax savings: If tax rates rise or you’re in a higher bracket later, paying taxes now could save money.
• Potential benefit for heirs: Beneficiaries inherit Roth IRAs tax-free once the account has been open for 5 years (including the time the original owner held it).

Cons:

• Upfront tax bill: You’ll owe taxes on the converted amount, which could be significant.
• Tax bracket risk: Converting too much at once might push you into a higher bracket which not only means higher taxes but also could lead to increased Medicare costs.
• Planning complexity: Timing and amounts require careful thought.

Taxes Now Versus Taxes Later

The core question of a Roth conversion is: would you rather pay taxes now or later? With a traditional IRA, you get a tax deduction upfront, but withdrawals in retirement are taxed, and the amount you withdraw factors into your income tax bracket for that year. A Roth conversion flips that—you pay taxes on the converted amount now but enjoy tax-free withdrawals later. In retirement, you might temporarily be in a lower tax bracket, making it a potentially opportune time to pay taxes on conversions. This can be a win if you expect to be in a higher tax bracket in retirement (perhaps due to required minimum distributions, or RMDs) or if tax rates rise in the future. Since predicting tax rates is tricky, consult with your financial planner and tax professional to weigh your options.

Roth Conversion Rules and Tax Bracket Management

When you convert funds to a Roth IRA, the amount you move is added to your taxable income for that year, meaning you’ll owe income taxes based on your current tax bracket. Timing and amount are key here. There’s no limit to how much you can convert annually, but converting a large sum could push you into a higher tax bracket, increasing your tax bill.

One strategy is to manage your tax brackets by converting smaller amounts over multiple years. For example, if your taxable income is $80,000 and the 22% tax bracket tops out at $90,000 for your filing status, you could convert $10,000 without jumping to the 24% bracket. By spreading conversions out, you can potentially minimize taxes while steadily building your tax-free Roth IRA over time.

The 5-Year Rule(s)*

There are two separate 5-year rules to understand when it comes to Roth IRAs, especially if you've converted funds from a traditional IRA.

1. The 5-Year Rule for Earnings (Applies to Everyone)

To withdraw earnings (investment growth) tax-free:

• You must be at least 59½ years old, and
• Your Roth IRA must be at least 5 years old (starting from January 1 of the year you made your first contribution or conversion).

If both conditions are met → Earnings can be withdrawn tax-free.If not → Earnings may be taxed and penalized.

2. The 5-Year Rule for Conversions (Mainly for Those Under 59½)

Each time you convert money from a traditional IRA to a Roth IRA:

• A separate 5-year clock starts for that conversion.
• If you withdraw the converted amount before 5 years have passed:
• And you're under 59½ → You’ll pay a 10% early withdrawal penalty.
• If you're 59½ or older → No penalty applies.

Once you're over 59½ → Converted funds can be withdrawn anytime, penalty-free.

Bottom Line

• Converted principal is generally flexible, especially after age 59½.
• Earnings have stricter rules: you need to meet both the age and 5-year requirements to withdraw them tax-free

The Importance of Roth Conversions for Leaving Money to Heirs

If leaving a financial legacy is important to you, a Roth conversion can be a powerful planning strategy. When a non-spouse beneficiary inherits a traditional IRA, they are subject to income tax on distributions at their own marginal tax rate. Additionally, under the SECURE Act’s 10-year rule, they must withdraw the full account balance within 10 years of your death—potentially accelerating their tax liability during peak earning years.

In contrast, Roth IRAs are inherited income-tax-free, as long as the account has been open for at least five years. Beneficiaries are still subject to the 10-year distribution rule, but they owe no income tax on the withdrawals, which can make a significant difference.

Example:Suppose your child inherits a $500,000 traditional IRA and has an effective tax rate of 30%. If they take equal distributions over 10 years, they would owe around $15,000 per year in federal income taxes, totaling $150,000 over the decade. If that same account were a Roth IRA, they could withdraw the entire $500,000 tax-free—a major boost to their financial future.

Since Roth IRAs also have no required minimum distributions (RMDs) during your lifetime, the money can continue growing tax-free for longer, further increasing the potential inheritance. For a tax-efficient estate plan, this strategy is hard to beat.

How Much Can You Convert to ROTH

There’s no cap on how much you can convert to a Roth IRA in a single year—but the tax hit matters. Since the converted amount counts as taxable income, a big conversion could mean a big tax bill or a jump to a higher bracket. Many opt for a “tax bracket filling” approach, converting just enough each year to stay within their current bracket. For instance, if you’re in a lower bracket now than you expect in retirement, converting a portion annually can maximize tax efficiency.

Working with a Financial Planner is Critical

Roth conversions sound simple, but they’re nuanced. A financial planner can tailor a strategy to your unique situation—analyzing your current taxes, projecting future rates, and calculating optimal conversion amounts. They’ll also align the move with other retirement factors, like Social Security or Medicare premiums, and help you avoid pitfalls. It’s a complex decision worth professional input.

Conclusion

Roth IRA conversions can transform your retirement income strategy and legacy planning. By grasping the rules, timing your conversions wisely, and partnering with a financial planner, you can unlock significant benefits. Tax laws can shift, so staying informed and consulting a professional is key. Ready for tax-free retirement income and a gift for your heirs? Explore Roth conversions—it might just be your retirement game-changer.