Roth Conversions--When it Makes Sense

Roth conversions have become an increasingly popular strategy for many individuals seeking to optimize their retirement savings. This financial tactic involves converting traditional IRA or 401(k) funds into a Roth IRA, which offers tax-free growth and withdrawals in retirement. While this can result in a hefty tax bill upfront, it can potentially save you money in the long run - especially if you expect your tax rate to be higher in retirement.

So, how exactly do Roth conversions work? Essentially, you will transfer funds from your traditional retirement account to a Roth IRA, paying the income taxes on the amount converted. Once the conversion is complete, the funds in your Roth IRA will grow tax-free, and you can withdraw them in retirement without paying taxes. It's important to note that the funds must stay in the Roth IRA for at least five years to be able to access them penalty-free. Importantly, extra steps are required when filing taxes (form 8606).

Roth conversions make the most sense in certain situations. For example, if you are in a lower tax bracket now than you expect to be in retirement, it may be advantageous to pay taxes on the converted funds at your current tax rate. Additionally, if you have a significant amount of money in traditional retirement accounts and want to diversify the tax treatment of your savings, a Roth conversion could be a good option.

It's also worth considering a Roth conversion if you expect your tax rate to increase in the future due to changes in your income, tax laws, or other factors. By paying taxes on the converted funds now, you can potentially save money down the road when you make tax-free withdrawals in retirement.

However, Roth conversions may not be the best choice for everyone. If you don't have the funds to pay the taxes on the conversion without tapping into your retirement savings, it may be better to wait until you are in a better financial position. Additionally, if you are already in a high tax bracket or close to retirement, the benefits of a Roth conversion may be limited.

Before deciding to do a Roth conversion, contact Paul at Carriere Financial Planning. We can help you assess your individual situation and determine if a Roth conversion is the right strategy for you. Ultimately, Roth conversions can be a powerful tool for increasing your tax efficiency and maximizing your retirement savings, but it's crucial to carefully consider the potential benefits and drawbacks before making a decision.

About the author:

Paul Carriere CFP® provides fee-only financial planning and investment management services in Colorado Springs, Co. and nationwide. Carriere Financial Planning serves clients as a fiduciary and never earns a commission of any kind. Paul has over 10 years of experience as a financial advisor in Colorado Springs. 

* This content is developed from sources believed to be providing accurate information. The information provided is not written or intended as tax or legal advice and may not be relied on for purposes of avoiding any Federal tax penalties. Individuals are encouraged to seek advice from their own tax or legal counsel. Individuals involved in the estate planning process should work with an estate planning team, including their own personal legal or tax counsel. Neither the information presented nor any opinion expressed constitutes a representation by us of a specific investment or the purchase or sale of any securities.