When planning for retirement, Roth conversions can offer a powerful strategy for long-term tax savings. Converting a traditional IRA to a Roth IRA means paying taxes upfront but benefiting from tax-free growth and withdrawals in retirement. However, the timing of the conversion is crucial, as it impacts the overall tax liability and your future financial flexibility. In this article, we explore the pros and cons of Roth conversions and the five optimal times for making the switch.
Why Consider a Roth Conversion?
A comprehensive retirement income plan should strategically balance cash flows, ensuring that your assets align with your living expenses throughout retirement. To build an effective plan, consider the following key reasons for a Roth conversion:
- Tax-Free Withdrawals in Retirement:
Unlike a traditional IRA, which is funded with pretax dollars and taxed upon withdrawal, a Roth IRA allows for tax-free withdrawals in retirement. Additionally, Roth IRAs are not subject to required minimum distributions (RMDs) for the original owner, providing greater flexibility in managing retirement income. - Upfront Tax Cost for Long-Term Gain:
The main trade-off with a Roth conversion is paying income tax on the converted amount in the year of conversion, which may temporarily increase your adjusted gross income (AGI) and tax rate. However, the benefit of tax-free growth and withdrawals can make this trade-off worthwhile, depending on your financial situation.
Five Optimal Times for Roth Conversions
- When the Market Is Down: A downturn in the stock market can be an ideal time for a Roth conversion. If your portfolio’s value decreases, you will pay taxes on a lower amount. For example, if your traditional IRA value drops from $100,000 to $70,000, converting at this lower value means you pay tax on $70,000 rather than $100,000. When the market rebounds, your assets will grow tax-free within the Roth IRA.
- When Anticipating a Change in Tax Brackets: With the expiration of certain provisions in the Tax Cuts and Jobs Act at the end of 2025, tax rates are expected to rise. Converting to a Roth IRA while current tax rates are low can lead to significant savings if rates increase in the future.
- During the Gap Between Retirement and RMD Age: The period after retirement but before RMDs begin (currently at age 73) often presents a lower-income phase, creating a favorable tax environment for a Roth conversion. This is an opportunity to convert portions of your IRA over multiple years, avoiding a substantial tax hit in any single year.
- When Experiencing a Lower-Income Year: A temporary reduction in income—such as a job change, a career break, or other life events—can provide a lower tax bracket, making it an opportune time for a Roth conversion.
- When Planning Ahead for Your Heirs: A Roth conversion can be an effective estate planning strategy, as it reduces the tax burden on your heirs. Beneficiaries can generally take tax-free distributions, though non-spouse beneficiaries must follow certain distribution rules and withdraw all funds within 10 years.
Timing Matters: Roth Conversions for a Flexible Retirement Strategy
The timing of a Roth conversion significantly impacts your retirement savings and tax liability. Whether it’s capitalizing on a market downturn, leveraging a lower tax bracket, or planning for heirs, these strategic windows can help you maximize the benefits of a Roth conversion. As with any tax-related decision, consult with a financial advisor or tax professional to determine the best approach for your unique situation.
Making strategic Roth conversions can provide tax-free income in retirement, greater financial flexibility, and potentially a lower lifetime tax bill. By optimizing the timing and approach, you can enhance your retirement savings, empowering you to enjoy your hard-earned wealth on your own terms.
If you are a Legacy client and have questions, please do not hesitate to contact your Legacy advisor. If you are not a Legacy client and are interested in learning more about our approach to personalized wealth management, please contact us at 920.967.5020 or connect@lptrust.com.
This newsletter is provided for informational purposes only.
It is not intended as legal, accounting, or financial planning advice.
