Should You Convert to a Roth IRA?

When planning for your Golden Years, converting your retirement plan to a Roth individual retirement account, or Roth IRA, can be a smart financial move. But there are pros and cons, so make sure you understand them before making the leap.

What Is a Roth IRA Conversion?

A Roth IRA conversion involves transferring funds from a tax-deferred account – such as a traditional IRA or a 401k – into a Roth IRA. The funds need to be rollover-eligible, of course. You can convert any amount and can make as many conversions within a year that you like.
 
Why might you do this? Once you transfer those funds into a Roth IRA, it grows tax-free1 for life, so you can hang onto more of your earnings. You can also withdraw funds tax-free, as long as you follow the rules. (Keep in mind that you won’t get a tax deduction for deposits, as you would with a traditional IRA. And you will pay any taxes due on the funds you convert that year.

Possible Benefits

A Roth IRA offers some benefits worth considering.

• Provides tax-free growth. Once you convert funds to a Roth IRA, any future gains are tax-free.
• Withdrawals of earnings in retirement are tax-free if you are at least 59½ years old or disabled and have had held your Roth IRA for at least five years. Contributions to a Roth IRA are made with post-tax money or by rolling over funds from your traditional IRA, where taxes have already been paid on contributions and any earnings. Any earnings after converting to a Roth IRA are also tax-free.
• Can make early withdrawals to buy your first home. Five years after opening a Roth IRA, you can withdraw $10,000 tax-free to help buy your first home – even if you’re not yet 59½ years old.
• Don’t have required minimum distributions (RMDs). This gives Roth IRA holders more time to let their money grow. With a traditional IRA, you’re required to start withdrawing funds by April 1 of the year after you turn 73. With a 401k, you need to begin making withdrawals at age 72 or 73, depending on when you were born.
• Can leave your loved ones a tax-free inheritance. Your heirs will be able to withdraw money from your Roth IRA tax-free, as long as the account has been open for at least five years when you die.

Things to Consider Before Converting

Depending on your situation, converting may reduce your taxes to help grow your retirement savings.
 
It especially makes sense to do a Roth IRA conversion if:

• You’re experiencing a dip in your income. You’ll pay federal income taxes for the current tax year on any funds converted from your traditional IRA or 401k to a Roth IRA. You may also pay state income tax, depending on the state you live in. So you’ll pay lower taxes now, at your lower income, than if you wait until after your income rebounds.
• The market is down. Again, you’ll need to pay taxes due on any contributions or earnings in your traditional retirement account. So if a downturn in the market caused the value of your IRA to drop from $80,000 to $65,000, there’s a silver lining. You can pay the lower taxes on that $65,000 and then direct those funds into a tax-free Roth IRA.
• You expect your income to rise in retirement. If you’re likely to be in a higher tax bracket after you retire, moving funds into a Roth IRA now will allow you to enjoy some tax-free income later on.
• You don’t want to take RMDs in retirement. The IRS doesn’t require that you start taking minimum withdrawals from a Roth IRA at age 72 or 73, as you must do with a traditional IRA or 401k. That means your money can continue to grow and, if you’d like, you can pass it on to your spouse or heirs.
• You won’t need to withdraw funds right away. A Roth conversion may not be the best option, though, if you’ll need access to funds early. If you withdraw funds before you turn 59½, and before 5 years have passed since your first contribution, you’ll pay income taxes and a 10 percent penalty on earnings.

Be Sure Before You Convert

Once you do a Roth IRA conversion, you can’t “undo” it. The Tax Cuts and Jobs Act of 2017 made Roth IRA conversions irreversible.

Can You Convert a 401k to a Roth IRA?

Maybe. Some companies allow only former employees to roll their 401k into a Roth IRA, while others allow current employees to do it too. So be sure to check your plan’s restrictions before moving ahead. (Remember that you’ll owe income taxes now on the amount that you roll over, but once that money is in your Roth IRA, withdrawals will be tax-free.)
 
If you can only roll over your 401k to a traditional IRA, you can take that step first. Then later on, you can open a Roth IRA and do a conversion.

Can You Convert a Traditional IRA to a Roth IRA?

Yes. You can convert a traditional IRA to a Roth IRA at any age. Just be aware that you’ll pay income taxes on any amount you convert that would have been taxed if you’d withdrawn it. There’s no limit to the amount you can roll over.

Steps to Convert to a Roth IRA

Considering a Roth IRA conversion? Take these steps:

• Evaluate whether a Roth IRA conversion is right for you.
  Talk to a financial advisor who can guide you.
  • Ask whether a rollover will bump you into a higher tax bracket. If so, you may want to convert just some of the funds.
  • Consider the market. If your retirement account has lost value, it might be a good time to roll over funds.
• Open a Roth IRA account.
  Open a Roth IRA account (unless you already have one).
• Initiate the transfer or rollover.
  There are two ways to move funds into your Roth account. A direct transfer is the easiest. Some plan administrators can make the check payable to the new custodian for your Roth IRA. If a transfer is not an option, you can roll over the funds. Your plan administrator can give you a check (made out to your new Roth IRA account), which you’ll need to deposit within 60 days.
• Pay taxes.
  Whether you transfer or roll over your funds, the full amount will be added to your gross income for the year, so you’ll pay income tax on it that year. Also with a rollover, you’ll need to roll over the entire amount of funds within 60 days to avoid paying a withdrawal penalty.

¹ Consult a tax advisor about Roth IRA tax advantages.

Sources:

Britannica Money, “Roth conversions: What are they, how they work, pros and cons,” accessed October 30, 2024 Internal Revenue Service, “Rollover to a Roth IRA or a designated Roth account,” accessed October 30, 2024

Internal Revenue Service,
Retirement Topics – IRA Contribution Limits,” accessed November 12, 2024

Internal Revenue Service, “Topic no. 557, Additional tax on early distributions from traditional and Roth IRAs,” updated December 21, 2023

AARP, “Everything You Need to Know About Roth IRAs,” updated July 9, 2024

AARP, “How to Convert a Traditional 401(k) Into a Roth IRA,” published May 2, 2023

MarketWatch, “When is the best time to do a Roth IRA Conversion? Here’s how to make the most of this potentially tax-savvy move,” updated August 12, 2024