Understanding IRA to Roth IRA Conversions

In last week’s article, 4th Quarter investment success, we discussed several ways to position your portfolio for year-end planning.  We reviewed strategies that included rebalancing between/within asset classes, tax loss harvesting, and the IRA to Roth IRA Conversion.  We’ll now go into additional detail with IRA to Roth IRA conversions, as it is an underutilized strategy that can have a big payoff if executed correctly.

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Understanding Roth Conversions

The strategy involves voluntarily paying taxes to convert money from a Traditional IRA (Tax Deferred Account) to a Roth IRA (Tax-Free Account).  The intent of the strategy is to pay taxes now in a lower tax bracket and transfer money to the tax-free environment of a Roth IRA to avoid potentially greater taxes in the future.

Who Should Consider This Strategy

The Roth Conversion strategy requires a comprehensive understanding of one’s financial situation; there are general circumstances where one should consider its use:    

Those in lower marginal tax brackets who could move to higher tax brackets later in life. For example, retirees may want to consider this strategy before they initiate their social security benefit, or before they reach the age of Required Minimum Distributions (RMDs), which is currently the age of 72.  Remember, there are no RMDs for Roth IRAs.  NOTE:  If you are currently in a higher tax bracket and on the cusp of moving to a lower tax bracket based on loss of income, retirement, etc., the timing of this strategy may not be right for you. You should discuss your case with your financial advisor.

Those who will not need all their pre-tax Traditional IRA assets in retirement and will bequeath those assets to non-spouse beneficiaries. Why is this the case?  Due to the new 10 Year Rule pertaining to the inheritance of pre-tax IRAs by non-spouse beneficiaries, where the assets must exit the account within 10 years and be subjected to ordinary income tax, these beneficiaries could potentially pay much more in tax than necessary.  The IRA to Roth Conversion could help reduce, or alleviate, this potential tax situation because while an Inherited Roth IRA is still subject to the 10 Year Rule, the non-spouse beneficiary would pay no tax due to the tax-free nature of the Roth.       

While the IRA to Roth IRA Conversion is a great tool to save money on taxes, it is often a long-term play and there are numerous factors to consider. *Review your specific circumstances and consult your financial advisor, or tax professional, before executing this strategy. *


Marshall Clay CFP, J.D., is a Partner and Senior Advisor at The Welch Group, LLC, specializing in providing Fee-Only investment management and financial advice to families throughout the United States. Marshall is a graduate of the United States Military Academy in West Point, New York, the Cumberland School of Law in Birmingham, Alabama, and is a CERTIFIED FINANCIAL PLANNER™.  In addition, Marshall is a frequent guest on local television stations as an expert on various financial planning matters.


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