6 Signs It's the Right Time for a Roth Conversion
A Roth conversion can lower your lifetime tax bill and help you leave a tax-free legacy for your heirs. But the upfront costs can be steep, so you'll need to get the timing right.
After years spent building a retirement fund, giving up hard-earned growth to tax can sting. Yet, that's precisely what happens when you begin taking withdrawals from tax-deferred accounts such as your traditional IRA or 401(k).
If you're looking to shield your retirement distributions from tax, a Roth conversion may be just the ticket.
Roth conversions involve moving funds from a tax-deferred account into a Roth IRA. In addition to growing tax-free, money in a Roth account can be withdrawn on a tax-free basis after age 59½, provided your account has been open for at least five years.
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Those tax-free withdrawals are the carrot, but there's also a stick — you'll owe taxes on the converted amount in the year of the conversion. Depending on your income level, tax bracket and the size of the conversion, that tax bill can be steep.
However, if you time it right, Roth conversions can deliver benefits for years to come. Here are six signs the timing may be favorable.
1. You expect your tax bracket to rise
Although there's a generalized assumption that your income will fall during retirement, potentially dropping you into a lower tax bracket, experience doesn't consistently bear that out.
While many of our clients see their income drop immediately post-retirement, it often rises again once Social Security, pensions and/or required minimum distributions (RMDs) kick in. That can make the years between stopping work and receiving that extra income a sweet spot for Roth conversions.
Of course, you don't need to be on the cusp of retirement to make this work. Converting ahead of a big raise, restricted stock unit (RSU) vest, business sale or inheritance may also let you take advantage of lower tax brackets now.
With some advance planning, you can even convert a portion of your IRA each year during your lower income windows. The idea is to convert just enough to stay within your target tax bracket. With each conversion, you shrink the portfolio balance that would eventually be subject to RMDs. That's because RMD rules don't apply to Roth accounts.
We helped one of our clients use this strategy to convert nearly his entire portfolio to a Roth IRA before age 73, when his RMDs would have started. Bolstered by a solid financial plan, he now lives off a separate trust account and plans to pass his multi-million-dollar Roth account to his heirs entirely tax-free.
2. It's a low tax rate environment
Back in 2017, the Tax Cuts and Jobs Act reduced tax rates across the board, and the One Big Beautiful Bill Act recently made those lower rates permanent.
This opened the window for near-term strategic planning. After all, "permanent" is relative when it comes to tax policy, meaning rates could rise again in the future.
Converting amid today's lower rates allows you to lock in current costs. Waiting means betting on rates remaining steady.
3. You won't need the money for several years
Roth accounts come with their own timeline. After each conversion, you need to wait five years before you can withdraw the converted principal. Earlier withdrawals may be subject to a 10% penalty. Once you turn 59½, however, this penalty no longer applies.
There's also a second five-year rule. To withdraw earnings tax-free, you need to wait at least five years since your first Roth contribution or conversion and you must be 59½ or older. In practice, this means a late-in-life first conversion can prevent you from withdrawing your earnings tax-free for years.
If you anticipate needing the money as a primary source of retirement income, this makes conversion timing doubly critical. However, if you have a multi-year runway and can access other funds in the interim, it's worth considering.
4. During periods of market volatility
Although market downturns can be daunting, they can also open hidden opportunities. That's because Roth conversions are taxed based on the current value of your holdings, not on what you originally paid.
As a result, a decline lets you convert more of your portfolio at the same tax cost you would pay when values are high, or convert the same dollar amount while paying less tax to do so.
Plus, once those assets are inside the Roth account, any recovery happens tax-free. This lets you turn short-term market volatility into a long-term advantage.
5. You're below an income threshold that matters
While many people pay attention to tax rates and tax brackets when completing a Roth conversion, they don't always consider income thresholds.
However, any money you convert to a Roth account is considered part of your income for the year. This tends to lead to a common misstep: Retirees convert a large amount without considering the impact on their Medicare premiums.
Income-related monthly adjustment amount (IRMAA) surcharges are calculated using your income from two years prior. If you don't take earlier Roth conversions into account for Medicare purposes, you may end up paying higher premiums than you expect.
To avoid unwelcome surprises, consider working with a qualified adviser who can model your tax bracket and IRMAA bracket together so you can decide if the time is right for a Roth conversion.
6. You want to benefit your heirs
Roth conversions aren't only about your own retirement. Since Roth withdrawals are tax-free, money left in the account passes to your heirs on a tax-free basis. This can translate into meaningful tax savings, especially if your beneficiaries inherit during their prime earning years.
This matters more now that inherited IRA rules have tightened. Non-spouse heirs are generally now required to withdraw all the funds from an inherited IRA within 10 years of the original owner's death. That compressed window can create a significant tax burden for children who inherit a traditional IRA.
So, even if you're in your 80s or 90s, a Roth conversion may make sense if you don't plan to spend the money yourself.
Before you act
Even when the timing seems right, it pays to pinpoint exactly what you'll owe in advance. A conversion's tax bill depends on your full financial picture and it's easy to miscalculate.
A financial adviser can help you run the numbers and determine the best way to cover taxes owing. For example, while you could prepay tax using the converted funds themselves, this would shrink the very balance you're trying to grow tax-free.
Structured planning can help you avoid this and other common mistakes, so you can reap the long-term benefits of a Roth conversion.
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