July 24, 2020

Edited 09/04/20

Roth IRA for Retirement: When to Convert

Know the strategy of when to convert your assets to a Roth IRA to save on taxes.

For some investors, converting money from a traditional IRA to a Roth IRA can be a smart choice to save money and improve their estate plan.

A Roth IRA is a retirement account that allows your money to grow tax-free. With a Roth IRA, you pay taxes now, based on your current tax bracket, and you don’t pay any taxes or penalties when you withdraw the funds at retirement. With a traditional IRA, you pay taxes later, based on your future tax bracket, as you withdraw the funds. 

Unlike 401(k)s and traditional IRAs, Roth IRAs do not have a Required Minimum Distribution after you reach a certain age. Your Roth IRA funds can be invested in mutual funds, stocks, bonds, exchange-traded funds (ETFs) or bank savings products.

Should I Convert My Assets to a Roth IRA?

It all comes down to what you think your tax rate will be in the future, compared to what it is now. If you think it will be lower in the future, then you should not convert to a Roth IRA. If you expect your tax rate will stay the same or increase, then you should convert to a Roth IRA.

For example, if you think you’ll be earning significantly more during your retirement (based on projections for your work, investment returns, inheritance, real estate, etc.), then you should convert to a Roth IRA now. Likewise, if you anticipate large tax hikes in the future, then you should convert to a Roth IRA now.

Calculate Your Future Income

Plan ahead and see when you expect an income change. This will help you determine when you should convert your assets into a Roth IRA account. Silvur will help you calculate your projected income by age for you to determine when you can expect a change in your future income. It will total your total project net worth, income, and expenses to help you determine when is a good time to convert your assets into a Roth IRA account.

What to Know About Converting to Roth IRA?

After the conversion, you (or your beneficiary) won’t have to pay taxes on the distributions as long as you’re at least 59.5 years old, and if you’ve owned the account for at least five years. 

Convert When Expecting Lower Income

If possible, consider converting in a year when you are expecting a lower income than normal. This is possible if your income varies substantially from year to year, which is often the case for entrepreneurs, sales professionals and consultants. If your income is steady every year, consider converting a part of your traditional IRA to a Roth IRA over multiple years.  

There is no limit on the amount of money that you can convert to a Roth IRA. The goal of the conversion is to save more money for retirement and pay less in taxes.

Conversion Impact on Taxable Income

When you convert to a Roth IRA, the amount of the conversion will increase your taxable income, so you need to be sure it does not nudge you into a higher tax bracket. This is where spreading the conversion over several years may be a good idea.

Since your future tax rate is uncertain, it may be a good strategy to keep some assets in a traditional IRA and some in a Roth IRA. That’s what is known as diversification by tax type.

Paying Taxes on Roth IRAs

There are two ways to pay for the federal and state taxes due at the time of a Roth IRA conversion. You can pay from:

  1. Non-retirement assets (like your savings or checking account)
  2. Traditional IRA proceeds

To preserve your retirement security, the preferred method is paying the taxes from an outside source and not from your retirement savings income. If possible, try to convert to a Roth IRA after you have enough money saved up to pay the taxes without dipping into your retirement savings.

Roth IRA for Estate Planning

Using a Roth IRA can be an important part of your estate plan. It’s a way to reduce your estate taxes after your death. For example, your Roth IRA can pass tax-free funds to your spouse, children and grandchildren, making a great inheritance for them. Under the SECURE Act, the Roth IRA must be distributed within 10 years but beneficiaries can let the Roth account grow and then take the entire distribution at year 10 with no tax consequences. 

Be sure to name a beneficiary as soon as you open your Roth IRA and review it periodically, so it remains up-to-date.

6 Things to Know When Converting to Roth IRAs

  1. Plan ahead and project your future income, assets, and net worth with Silvur.
  2. Convert to a Roth IRA if you expect your tax rate will remain the same or increase in the future.
  3. Convert your retirement funds to a Roth IRA when you’re in a lower tax bracket.
  4. If you don’t see a change in income over the years, consider spreading the conversion over a period of time but make sure the amount doesn’t put you in a higher tax bracket. 
  5. Try to pay for the Roth IRA conversion tax from an income source other than your retirement income.
  6. Name a beneficiary to your Roth IRA account and be sure to review periodically.