Roth Conversions: Strategic Planning for Tax-Efficient Retirement Savings

May 21, 2024  |  Doug Frawley

Planning for retirement can be complex, but using strategies like Roth conversions can offer significant tax savings and financial flexibility to savvy investors.

In today’s issue, we’ll take a deeper look into Roth conversions to help you understand this powerful retirement planning tool.

A Roth conversion involves moving money from a traditional IRA or 401(k) into a Roth IRA. The main difference between these accounts is their tax treatment.

Traditional IRAs give you a tax break when you put money in, but you pay taxes when you take it out during retirement.

In contrast, Roth IRAs require you to pay taxes when you contribute, but you don’t pay taxes on withdrawals, provided you meet certain conditions.

One of the main advantages of a Roth conversion is tax-free growth. Once your money is in a Roth IRA, it grows without you having to pay taxes on the earnings. In addition, Roth IRAs don’t have required minimum distributions (RMDs), unlike traditional IRAs.

This means you are not forced to withdraw money at a certain age, giving you more control over your retirement funds.

Having both traditional and Roth accounts also provides tax diversification, which can help you manage your taxable income more effectively in retirement.

The main purpose of a Roth conversion is for you to pay taxes now to avoid paying higher taxes later. This can be particularly beneficial if you anticipate being in a higher tax bracket during retirement.

The potential savings from a Roth conversion depend on several factors, including the amount you convert, current and future tax rates, and the growth of your investments.

So when does a Roth conversion make sense?

Well, if you have a year with unusually low income, you might fall into a lower tax bracket, making it an ideal time for a conversion because you’ll pay less in taxes.

Converting before RMDs begin can help manage your taxable income in later years.

Additionally, if you expect tax rates to rise or foresee a higher personal tax rate in retirement, converting now can lock in the current lower rates.

However, a Roth conversion may not always be advantageous.

If you’re currently in a high tax bracket, the immediate tax hit from a conversion might not be worth it. Similarly, if you need to withdraw from your Roth IRA soon after conversion, you won’t benefit much from the tax-free growth.

It’s also important to consider whether you have enough funds outside your retirement accounts to pay the conversion taxes. Using money from your IRA to pay these taxes could negate the benefits of the conversion.

Timing is crucial when it comes to Roth conversions. The best time to convert is when you are in a lower tax bracket than you expect to be during retirement.

Converting in years when the market is down can also be beneficial, as the reduced value of your investments will mean lower taxes owed on the conversion and the potential for significant tax-free growth when the market recovers.

Deciding if a Roth conversion makes sense for you involves considering several factors. Consider a Roth conversion if:

  • You can pay the taxes from money outside your retirement accounts.
  • You expect to be in a higher tax bracket in the future.
  • You want to avoid required withdrawals and extend the tax benefits of your retirement accounts.
  • You want to leave tax-free money to your heirs.

Before making a decision, think about the immediate tax costs, how long your money will grow, and your overall retirement plan. Consulting a financial advisor or tax professional can help you figure out if a Roth conversion is a good fit for your financial goals.

With careful planning, a Roth conversion can be a valuable tool to help secure your financial future in retirement.

Until next time,

If you’ve been considering hiring an advisor to help guide you through the ever-changing financial landscape, take your first step today by scheduling a free consultation with one of our experienced team members. There’s no risk in exploring if we’re the right fit for your financial goals. Contact us now.

Get Our FREE Guide

How to Find the Best Advisor for You

Learn how to choose an advisor that has your best interests in mind. You'll also be subscribed to ADAPT, Avalon’s free newsletter with updates on our strongest performing investment models and market insights from a responsible money management perspective.

Avalon_NewGradient_24Feb22 copy