Traditional retirement accounts are a pivotal part of any given person’s overall tax and wealth blueprint. Oftentimes, strategically taxing portions of a traditional retirement account in a "Roth conversion" leads to favorable tax, and non-tax outcomes. Taxpayers can use Roth conversions to lower their future tax burden, manage their current tax bracket, and pass further wealth on to their heirs.
What Is a Roth Conversion?
With a traditional IRA, contributions may be tax-deductible if certain requirements are met, and earnings grow tax-deferred (taxable upon withdrawal). On the other hand, with a Roth IRA, investments grow tax-free and contributions are not tax-deductible. Withdrawal rules also differ: as previously mentioned, traditional IRA withdrawals are generally taxed as ordinary income, while qualified Roth IRA withdrawals are tax-free. Another notable difference is that traditional IRAs have required minimum distributions (RMDs) starting at age 73 (or 75 for those born in 1960 or later), while Roth IRAs do not require RMDs during the owner’s lifetime.
The simple way to describe a Roth conversion is moving money from a traditional IRA to a Roth IRA. When you convert a traditional IRA to a Roth IRA, you pay tax on the amount you convert in the year of the transfer. In exchange, you generally won’t owe tax on qualified withdrawals later, as long as you meet IRS-prescribed requirements.
It should be additionally noted; as long as the full amount of the withdrawal is converted, the typical 10% early withdrawal penalty does not apply regardless of a taxpayer’s age. Failure to so, such as by having the IRA withhold to cover the conversion costs, could result in that portion being treated and taxed as a distribution and could be penalty-eligible if the taxpayer is under age 59 ½.
How Is a Roth Conversion Taxed?
Taxation is the key consideration when considering a Roth conversion. The converted amount is generally treated as ordinary income, which could push you into a higher tax bracket or otherwise increase your tax burden.
A Roth conversion may also increase your Medicare premiums because the converted amount is included in your modified adjusted gross income (MAGI), which Medicare uses to determine income-related monthly adjustment amount (IRMAA) surcharges. If the conversion pushes your MAGI above certain thresholds, it may also increase your exposure to the net investment income tax (NIIT). The converted amount itself is not subject to NIIT, but your other investment income, such as interest, dividends, capital gains, and certain passive income, could be.
Finally, if you live in a state with an income tax, the converted amount will generally increase your state taxable income as well. Illinois taxpayers, however, generally do not pay Illinois income tax on Roth conversions.
For many taxpayers, the question usually isn’t whether taxes will be due, but whether paying taxes today creates greater long-term value than paying them later.
Does a Roth Conversion Make Sense for Me?
Answering the following questions can help you figure out whether a Roth conversion aligns with your goals.
- What tax bracket are you in today? Comparing your current tax bracket with your projected future bracket can help you decide whether converting your traditional IRA makes sense.
- How much is in your traditional IRA? If your retirement account balance is large or expected to grow significantly, it may make sense. Larger balances lead to larger RMDs later in life. A Roth conversion may help reduce that future burden.
- Do you have outside cash available to pay taxes? Roth conversions mean you must pay taxes on the converted amount, and paying that tax with non-retirement funds is generally advisable.
- What are your estate-planning goals? For taxpayers with taxable estates, a Roth conversion can immediately shrink your taxable estate and could lower overall taxes due by your estate or heirs by shrinking the amount exposed to the estate tax.
- What is your retirement income strategy? Consider how taxable, tax-deferred, and tax-free assets fit into your overall plan. A Roth conversion can help diversify your tax exposure and provide more flexibility when you draw income in retirement. Consider the full picture including Social Security, RMDs, pension income, and other sources of retirement income.
Is There a Maximum Roth Conversion Amount?
The answer here is a simple no. The IRS has not set a dollar limit on conversions. This gives taxpayers flexibility beyond converting the full amount and allows them to focus on optimizing the conversion based on their broader tax and retirement goals. For example, you may choose a partial conversion, converting only enough to stay within your target tax bracket. You can also spread the conversion over multiple years to align with your income, tax-planning, and retirement goals. Working with an experienced tax advisor can help you set the right course for your situation.
Roth conversions aren’t just for retirees. Young professionals early in their careers are often in a lower tax bracket than they will be later, which can make it a good time to convert and pay tax on a smaller balance. High earners whose income is too high to contribute directly to a Roth IRA can also use a “backdoor Roth” strategy by making a nondeductible contribution to a traditional IRA and then converting it to a Roth IRA. (Keep in mind that the pro-rata rule may make part of the conversion taxable if you have other pre-tax IRA balances.) Either way, starting early gives your investments more years to grow tax-free.
Key Takeaway
Roth conversions can create long-term tax savings, improve your retirement income flexibility, and support wealth transfer goals. But it’s essential to fully analyze whether and when a Roth conversion makes sense for you, taking into account your current income, future tax exposure, estate-planning objectives, and liquidity.
Before converting a traditional IRA to a Roth IRA, work with advisors who can model tax consequences, evaluate long-term wealth outcomes, and align the strategy with your broader financial goals.
This content is for general informational purposes only and does not constitute tax, legal, or professional advice. Readers should consult their tax advisor regarding their specific situation before making any tax-related decisions.