Intellectual Capital

Retirement Planning

Roth Conversion Strategies to Consider

Roger Young, CFP®, Senior Financial Planner

Executive Summary

  • Anyone can take advantage of converting assets to Roth IRAs because there are no income restrictions.
  • Roth conversions are most compelling when you pay the taxes at a relatively low rate.
  • Converting assets early in retirement before you face required minimum distributions (RMDs) can reduce those RMDs (and the risk that they will increase your tax rate).
  • Roth conversion is one way to introduce tax diversification and favorable asset location to your investment strategy.
  • Even if your tax rate is expected to decrease in retirement, a Roth conversion may still be advantageous. 

Since 2010, all investors have been allowed to convert assets from a Traditional IRA to a Roth IRA.Because conversions are not subject to income restrictions, people at any income level can take advantage of the Roth’s key benefit—tax-free qualified distributions.2

A Roth conversion provides you with tax diversification in your retirement years. In addition, Roth IRAs do not have required minimum distributions (RMDs) for the original owner, whereas Traditional IRAs are subject to RMDs after you reach age 70½. These positives need to be weighed against the tax you pay on the amount converted.

Deciding whether a Roth conversion makes sense in your situation depends on several factors, including:
 

  • Your current and future tax rates,
  • Your mix of assets, and
  • Possibly your heirs’ future tax rates.

Advantages of Converting to a Roth

You can benefit from a Roth conversion by paying taxes now at a lower rate if your tax rate is likely to be higher when you take distributions. The strategy should be considered in a number of situations, if you are able to pay the taxes (preferably from a nonretirement account):

  • You expect your tax rate to be higher when you take account distributions. (This could include situations where your current income is unusually low.)
  • You plan to leave the assets to heirs whose tax rates will be higher than yours.
  • Your assets are primarily in taxdeferred accounts and you want more tax flexibility.
  • You want more opportunity to optimize asset location—holding different types of assets in different accounts.
  • You want a hedge against higher statutory tax rates. (For example, following the tax cuts passed in late 2017, you might believe that tax rates are unlikely to be any lower during your lifetime.)
  • You won’t need your RMDs for retirement expenses. As we will discuss further, even if your tax rate stays flat or decreases in retirement (despite the RMDs), a Roth conversion could be beneficial if you pay the taxes from an account that isn’t highly tax efficient.

Disadvantages of Converting to a Roth

The key disadvantage of a Roth conversion is taxes due on the converted value. There are a number of reasons your tax rate may be lower when you (or your heirs) take distributions:

  • Many people have lower income in retirement.
  • When you take retirement distributions, they may represent a large portion of your income and straddle tax brackets, resulting in a lower average tax rate. (In contrast, the conversion probably adds to the income taxed primarily at your marginal, or highest, rate.)
  • Some states don’t tax retirement distributions, or have no income taxes at all, which is important to consider if you might relocate. 

There are also factors to consider specifically for the year of conversion. Higher taxable income that year could have one or more of these negative effects:

  • A higher tax bracket,
  • A higher portion of Social Security benefits subject to tax,
  • Higher Medicare premiums, and
  • Less eligibility for student financial aid.

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Roth Conversion Strategies

Converting a Traditional IRA to a Roth account affords your investments tax diversification and the benefit of tax-free distributions in retirement.

1It may also be possible to convert assets from pretax to Roth within a retirement plan such as a 401(k). While many of the planning principles are the same, this paper focuses on conversions of IRAs.

2Generally, a distribution is qualified if taken at least 5 years after the year of your first Roth contribution and you’ve reached age 59½.

This material has been prepared by T. Rowe Price Group, Inc., for general and educational purposes only. This material does not provide fiduciary recommendations concerning investments or investment management. T. Rowe Price Group, Inc., its affiliates, and its associates do not provide legal or tax advice. Any tax-related discussion contained in this material, including any attachments/links, is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding any tax penalties or (ii) promoting, marketing, or recommending to any other party any transaction or matter addressed herein. Please consult your independent legal counsel and/or professional tax advisor regarding any legal or tax issues raised in this material.

An IRA should be considered a long-term investment. IRAs generally have expenses and account fees, which may impact the value of the account. Nonqualified withdrawals may be subject to taxes and penalties. Maximum contributions are subject to eligibility requirements. For more detailed information about taxes, consult IRS Publication 590 or a tax advisor regarding personal circumstances.

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