Skip to content

The Best Time to Do a Roth Conversion

If you have a traditional IRA, you may be wondering if you should convert it to a Roth IRA. A Roth IRA offers many benefits, such as tax-free growth, tax-free withdrawals, no required minimum distributions (RMDs), and more flexibility for estate planning. However, converting to a Roth IRA also comes with a cost: You have to pay income tax on the amount you convert.

So, when is the best time to convert an IRA to a Roth? The answer depends on several factors, such as your current and future tax rates, investment opportunity, and the length of time until you need the money. Here are some guidelines to help you decide.

Is your current tax rate lower than your future tax rate? 

If your current tax rate is lower than your future tax rate, converting an IRA to a Roth is likely going to benefit you. There are two factors to consider: your taxable income and federal tax rates.

Your Taxable Income

Will your future taxable income be higher or lower? Generally speaking, many workers that are early in their careers will find their taxable income will be higher in the future. On the other hand, those who are closer to retirement are at their peak earning years and will find their taxable income is likely to go down in retirement. 

There is a sweet spot for Roth conversions that I find many people hit when they first enter retirement. Those in the 60-70 age bracket who have retired have a lot of flexibility in planning their income and taxes. You’re not yet required to take required minimum distributions from IRA accounts and you can delay your social security benefits, thus significantly lowering your current taxable income. This makes it an ideal time to look at your situation and see if a Roth conversion is advantageous for you.

Federal Tax Rates 

Future income tax rates are unknown and depend on politics. That being said, I would assume that future tax rates are going to be higher than current rates. Current tax rates are fairly low compared to history in the US. From 1935 through 1980, the top marginal tax rate in the US was over 70%! 

We already know that tax rates are currently set to jump after 2025. That’s when the individual provisions in the Tax Cuts and Jobs Act expire, which will reset individual rates to their 2017 levels. 

The US budget deficit and debt levels are clearly at unsustainable levels. It’s easy to see that something will have to change in the future and I think it’s a good bet that individual tax rates will be higher. 

Do You Anticipate Significant Investment Growth? 

For instance, if you’d converted an IRA to a Roth in 2009 when stocks were especially attractive, you’d have enjoyed massive gains that are all tax-free today. Not only that, but your portfolio would likely have been down from 2007 so you would have paid less in taxes on the conversion.

The last factor in considering future investment growth is how long you can leave your money in a Roth before you start taking withdrawals. The longer you leave your money in a Roth the more advantageous its tax-free growth becomes. 

Caution- A Bird in Hand is Worth Two in the Bush

Years ago, I called a CPA friend who runs a local tax and accounting practice. We were discussing a mutual client who was considering a Roth conversion and I wanted to make sure we were on the same page in our advice. This CPA’s take on Roth Conversions surprised me. He said he almost always advises clients not to do a Roth conversion. He framed it this way: “Why would you ever want to voluntarily pay unnecessary taxes? You don’t know the future tax code.” That has always stuck with me. 

Who’s to say Congress won’t implement means testing for Roth IRAs in the future? They could remove tax benefits for those with higher balances or incomes. Early versions of the Build Back Better legislation included required minimum distributions for high-net-worth individuals regardless of age. That distribution included Roth accounts and was 50-100% of account balances over certain thresholds! 

While that proposal ultimately didn’t make it into law, it’s important to recognize that the future tax advantages of a Roth are not written in stone. There should probably be some discount on the future tax advantage you expect to realize on a Roth conversion to account for this uncertainty. Always pause before you volunteer to hand over your money to the government! 

Convert All at Once or Spread it Out?

If a Roth conversion is beneficial for your situation, you’ll need to decide whether to do a full or partial conversion. For those with larger balances, it often makes sense to do a partial conversion to ensure you’re not adding too much taxable income in the current year. You can do partial conversions and spread the tax liability out to best suit your situation. 

Before you decide to convert, you should consult with a qualified financial professional who can help you analyze the pros and cons of a Roth conversion and determine if it makes sense for you. At Sophos Wealth Management, we can help you with all aspects of your financial life, including Roth conversions. If you are interested in learning more about Roth conversions or any of our services, please contact me today for a complimentary consultation. 

Scott Caufield, CFA, CPA