How Roth IRA Conversions Could Fit Into Retirement Planning

young family of four plays soccer in the park as parents think about benefits of roth ira conversions

Key Takeaways

  • Roth IRA conversions allow you to convert traditional IRAs to Roth IRAs, providing tax-free withdrawals in retirement.
  • Though you pay taxes when converting, it avoids penalties for early withdrawals and potential surprise taxes in retirement.
  • Roth IRAs allow tax-free withdrawals after age 59 1/2 or 5 years after conversion.
  • There are no income limits on Roth conversions, unlike direct Roth contributions.
  • Consider if conversion makes sense based on current vs future tax bracket and having funds to pay conversion taxes.

Whether retirement is near or far off, now is the time to evaluate savings strategies. Converting traditional IRAs to Roth IRAs can benefit some future retirees. Though taxes are due when converting, Roth IRAs offer tax-free withdrawals in retirement, creating long-term financial advantages.

Learn more about the basics and benefits of Roth IRA conversions, as well as the rules and potential implications they could have for your retirement saving strategy.

The Differences & Benefits of a Roth IRA

The basic difference between a Roth IRA and a traditional IRA is when taxes are paid. With a traditional IRA, the funds you contribute may be tax-deductible for the year you contributed them, but when you retire, any deductible contributions and earnings that are distributed are taxable. With a Roth IRA, you contribute after-tax funds, and when you retire, distributions are not subject to tax so long they qualify (see below). Accordingly, to complete a Roth IRA conversion, you must pay income taxes on the traditional IRA you would like to convert.

With Roth IRA conversions, you can also potentially avoid penalties for accessing cash before retirement age. Paying taxes on income you've earned can be unpleasant at any stage of your life. But it can really sting if you need to access money in your retirement account before you've reached age 59 1/2 and it triggers early withdrawal penalties and taxes, according to the Internal Revenue Service (IRS).1

If you withdraw funds from a Roth IRA before age 59 1/2, you can avoid taxes on contributions and earnings, but may still owe a 10% penalty. Withdrawing from a traditional IRA before 59 1/2 can trigger taxes plus a penalty. Once your Roth IRA reaches age 5 years old and you hit 59 1/2, withdrawals are tax-free. This also applies to withdrawals by beneficiaries, for first home purchases up to $10,000, and if you become disabled.

Why Convert to a Roth IRA?

A conversion can also help you eliminate surprise tax bills when you're retired. Once you're between the ages of 59 1/2 and 70, you could withdraw from either a Roth IRA or a traditional IRA without the 10 percent additional tax penalty. However, taxes may still apply.

You may qualify for Roth IRA conversions even if you can't contribute. The IRS says that for the 20 tax year, single filers must have a modified adjusted gross income (MAGI) of less than $146,000 to contribute to a Roth IRA, and the amount you can contribute lowers for those with a MAGI of at least $146,000. Married tax filers must have a combined MAGI of less than $230,000, and their eligible contributions are reduced beginning at $230,000.2

There's no income restriction for Roth IRA conversions, however, as long as you complete the transaction and move funds from your traditional IRA to a Roth IRA within a 60-day window, you'll avoid penalties.

Roth IRA conversions can also be used as an inheritance for loved ones when the owner of a Roth account dies. Whoever inherits the money can withdraw it tax-free when they want — and in the amounts they choose.

Roth IRA Conversion Considerations

It's important to note that you'll need cash to pay the taxes you owe on the conversion. One of the main benefits of converting retirement assets to a Roth IRA is to reduce the amount of tax owed when you take distributions from the account in retirement.

However, Roth IRA conversion rules state you must pay taxes on the amount of money you convert in the year you complete the conversion. If you're under age 59 1/2 when you make the conversion and want to use the converted funds to pay the tax you owe, you'll get hit with an early withdrawal penalty. In light of these restrictions, it might be worth considering whether you'll really benefit from a Roth IRA conversion given how much you'll potentially pay in taxes.

You'll also have to guess your future tax bracket with Roth IRA conversions. Roth IRA contributions can be beneficial for younger workers: They'll presumably pay a higher income tax in retirement than at the start of their working lives. It follows that taxpayers who are already in the upper tax brackets might benefit less from Roth IRA conversions, as it's less likely they'll be in an equal or higher tax bracket after retirement.

The Bottom Line

Roth IRA conversions can provide multiple potential benefits to a retirement savings strategy. But it's important to take your unique situation into account before assuming a conversion is the best move for you.

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  1. IRA FAQs - Distributions (Withdrawals).
  2. 401(k) limit increases to $23,000 for 2024, IRA limit rises to $7,000.

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