To Convert or Not to Convert

To Convert or Not to Convert

Published On: January 9, 2025

Written by: Ben Atwater and Matt Malick

We get regular inquiries about the wisdom of Roth IRA conversions. We think the questions stem from the large volume of financial journalists who write on this topic with the frequently held conclusion that Roth conversions are a good idea.

They sometimes are but more often they are not. The decision to convert is highly individualized, which is the key point most commentators miss.

A Roth IRA conversion is the process of moving assets from a pre-tax retirement account – e.g. a traditional IRA, 401(k), or 403(b) – into a Roth IRA. The converted amount is taxed as ordinary income in the year of the conversion, but the funds in the Roth IRA will then grow and you can subsequently withdrawal them tax-free.

In working with clients over the years, we see five scenarios in which Roth conversions are sometimes appropriate.

1. The market is depressed:

Say the stock market dropped 45% like it did during the financial crisis. In this case, one could argue that the value of your portfolio is a fraction of what those investments will one day be worth again.

By doing the Roth conversion during a bear market, your resulting taxable income would be lower and, potentially, in lower tax brackets.

But with the market around all-time highs, we are skeptical of Roth conversions now. You would be paying taxes on what are not discounted investment values.

2. Your annual taxable income is below normal:

If your income in a particular year is temporarily depressed and your tax rate is lower than usual, it can be a compelling time to convert.

We use the word temporarily here because if your income is going to stay permanently lower, then it makes much less sense to convert.

But even this key factor does not make converting a slam dunk.

3. You have after-tax (non-IRA) cash with which to pay current income taxes:

The amount you convert to a Roth is taxable as ordinary income and affects your tax bracket. Most analysis about Roth conversion is silent on where you get the money to pay the taxes due. If you do not have non-IRA money with which to pay the taxes, you should not convert.

Withdrawing additional funds from your IRA to pay the taxes due from the conversion is a non-starter in our book.

4. You think future tax rates will be the same or higher:

This is the weakest Roth conversion scenario because it’s subject to speculation. Nobody can predict anything with any accuracy and future tax rates are no exception.

And, as things now stand, there are no proposals to increase income taxes with the new administration and new Congress.

5. You do not need your IRA for retirement and prefer to better prepare it for non-charitable heirs:

Like a depressed tax rate, this is another compelling reason. It’s pretty unique though.

Beginning in your 70s, you are required to withdraw a certain amount of your pre-tax IRA every year and pay taxes on that amount, known as a required minimum distribution (RMD).

And, at your death, what remains in your pre-tax IRA will presumably go to heirs who will also face the requirement of withdrawing the funds and paying ordinary income taxes on those withdrawals.  If the heirs inherit a Roth IRA, however, they will receive the funds tax-free.

Therefore, if you have excess funds outside your IRA that you will not need, and you want to pay the taxes under your terms, then a Roth conversion is something to consider.

But, even in this case, you may still want to wait for a major market pullback and / or have a depressed tax rate to do the conversion.

Roth IRA conversions are a complex topic, and this essay only scratches the surface. The bottom line is that Roth IRA conversions are extremely specific to one’s circumstances.

And, in our view, they make sense far less frequently than many recommend. Therefore, it is vital to do a deep dive when considering Roth conversions.

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