Why Some Retirees Consider Roth Conversions
A Roth conversion is the process of moving money from a traditional IRA or pre-tax retirement account into a Roth IRA.
The main difference between these account types comes down to taxes.
Traditional retirement accounts are generally funded with pre-tax dollars, meaning taxes are usually paid later when money is withdrawn. Roth IRAs work differently. Taxes are paid upfront, but future growth and qualified withdrawals can be tax free.
A Roth conversion is essentially choosing to pay taxes now instead of later.
Why would someone want to do that?
One reason is that some retirees may temporarily find themselves in lower tax brackets during the early years of retirement. For example, someone living primarily off savings before collecting Social Security may have lower taxable income for several years. This can create an opportunity to convert money at lower tax rates.
Another reason involves required minimum distributions, often called RMDs. Beginning at age 73 or 75 depending on birth year, the IRS requires withdrawals from most pre-tax retirement accounts whether the money is needed or not. These withdrawals are taxable and can potentially increase overall tax exposure later in retirement.
Roth IRAs do not have required minimum distributions for the original owner.
Some people also consider Roth conversions as part of estate planning. While inherited Roth IRAs are still generally subject to distribution rules, qualified withdrawals are typically tax free for heirs. This may provide more flexibility compared to inheriting taxable pre-tax retirement accounts.
Another consideration is what is sometimes called the “widow’s penalty” or “widow tax trap.” If one spouse passes away, the surviving spouse may eventually file taxes as a single individual rather than married filing jointly. Combined with taxable retirement withdrawals or RMDs, this can sometimes result in higher tax brackets later in life.
While Roth conversions can offer potential benefits, they are not automatically the right decision for everyone.
The amount converted, timing, current income, future income expectations, tax brackets, Medicare considerations, and available cash to pay taxes can all affect whether a conversion makes sense.
Roth conversions themselves are usually straightforward to execute. The more complicated part is determining whether converting is beneficial based on an individual’s overall financial and tax situation.
For some people, retirement planning software or professional tax guidance may be helpful when evaluating these decisions.
Here to make everyday money decisions easier,
Better Money Solutions
