Should You Convert Your Traditional IRA to a Roth IRA?

Quick Answer

Converting a traditional IRA to a Roth IRA could save you money on taxes in the long run, but you’ll need to pay tax on the conversion upfront.

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Saving money in an individual retirement account (IRA) is a good idea whether you have a tax-deferred traditional IRA or a tax-free Roth IRA. In some cases, though, a Roth may offer tax savings and access to funds that a traditional IRA does not. You can convert your traditional IRA into a Roth, but is it worth paying a sizable tax bill to do so?

Every situation is different. You might want to convert a traditional IRA to a Roth to realize tax-free growth, pass along tax savings to your heirs or take advantage of rules that allow penalty-free withdrawals from a Roth before you reach age 59½. Here's how a Roth IRA conversion works and when it might make sense for you.

Traditional vs. Roth: What's the Difference?

The main difference between a traditional IRA and a Roth IRA is when your money is taxed:

  • A traditional IRA is funded with pre-tax dollars. Traditional IRA contributions are deductible from your taxable income now, and your money grows tax-deferred until you withdraw it in retirement. When you do take your money out, you pay income taxes on every dollar you withdraw.
  • A Roth IRA is funded with after-tax dollars, so contributions are not deductible. However, earnings on your investments are tax-free and so are withdrawals as long as you follow IRS rules.

Both accounts save you money in taxes, but at different times. Which account is worth more when you retire? All things being equal, a $100,000 Roth account may be worth more when you retire than a $100,000 traditional IRA because none of the Roth money will go toward paying taxes.

A Roth Conversion Adds to Your Tax Bill

It is possible to convert your traditional IRA to a Roth, but the move comes at a cost. Here's the rub: When you convert a traditional IRA to a Roth, you pay taxes on the money you move. Moving a $500,000 IRA into a Roth? You'll add half a million dollars to your adjusted gross income for the year, which will not only generate a giant tax bill but will also likely move you into a higher tax bracket.

There are ways you can (and should) manage the conversion process to keep your bill manageable and stay in the lowest possible tax bracket (more on this later). For now, know that a Roth conversion is taxable upfront because it means pulling pre-tax money out of a traditional IRA.

5 Reasons to Consider a Roth IRA Conversion

When does it make sense to do a Roth conversion? Here are a few rationales:

1. You'll Save Substantial Money on Earnings

A conversion makes most sense for people who have years to go before retirement. When your money has more time to grow, not having to pay taxes on earnings makes more of a difference. Consult with your tax advisor and an investment strategist for help understanding your individual situation.

2. Your Income Is Too High to Make Regular Roth Contributions

The IRS restricts Roth contributions for taxpayers who exceed Roth IRA income limits. Converting a traditional IRA or old 401(k) to a Roth—also known as a "backdoor Roth"—lets you skirt these restrictions.

3. You'll Pay a Higher Tax Rate Later

Are you on the lower end of the income scale now? Do you believe tax rates will rise between now and retirement? If you believe your tax rate will be higher when you retire, a Roth could be advantageous.

4. Roth IRA Rules Work Better for You

Roth IRA rules on distributions differ from traditional IRA rules. You can pull out Roth IRA contributions (but not earnings) tax- and penalty-free at any time. You can also make penalty-free withdrawals (including earnings) if your money has been in your Roth account for at least five years and you are at least 59½ years old, disabled, or use the funds for a qualified expense such as unreimbursed medical expenses or a first-time home purchase. On a separate note, Roth IRAs do not have required minimum distributions: Money can stay in your Roth forever.

5. You Want to Pass Tax Savings to Heirs

If your children are designated beneficiaries on your Roth IRA, they'll have 10 years of tax-free growth to deplete the account after you die and won't have to pay taxes on their distributions. By contrast, they would have to take required minimum distributions from an inherited traditional IRA and pay taxes on that money as they go.

How Does a Roth IRA Conversion Work?

You can convert a traditional IRA or an employer-based plan from a former job (not your current one) by following these simple steps:

  1. Open a Roth IRA or use your existing Roth IRA account.
  2. Transfer money from your traditional IRA or old 401(k) account.
  3. Use IRS Form 8606 to report the conversion on your taxes.

You can make your tax bill more manageable by moving a large account over in parts. Say you're a single taxpayer with an adjusted gross income of $80,000 a year. Based on 2022 IRS tax brackets, you can convert $9,050 from a traditional IRA to a Roth without tipping into the next tax bracket. You'll pay 22% (or $1,991) in taxes and can repeat this process as many times as you'd like.

When Is It Best to Keep Your Traditional IRA?

Sometimes the cost of converting a traditional IRA to a Roth is simply too large to make the tax benefits worthwhile. Are you young, with many years until you retire? Converting now may pay off in the long run with relatively little risk. A $20,000 investment earning 8% per year may be worth $220,000 in 30 years. Even if your tax bracket remained steady at 22% between now and retirement, you'd pay $4,400 to convert now versus $48,400 when you withdraw it from a traditional IRA in 30 years.

On the other hand, if you're hoping to retire soon, your money simply doesn't have much time to compound. You may see some tax savings, but they probably won't be dramatic—and they may be reduced or eliminated if your investments drop in value or you wind up in a lower tax bracket after you retire (which is common if you don't plan to work, or plan to work less, when you retire).

Savings also depend on tax laws remaining as they are now. If laws change and Roth withdrawals are eventually taxed, you'll have paid a large tax bill for nothing.

Finally, if you don't have the cash to cover your Roth conversion tax bill, talk to your financial advisor about whether converting now makes sense for you. Pulling money out of your IRA to pay taxes will reduce the amount of tax-advantaged IRA money you have to invest.

Get Help Running the Numbers

Knowing whether a Roth IRA conversion makes sense for you means doing the math and taking your tax bracket, projected earnings and future income into account. Your tax and investment advisors can help you fill in the blanks—and devise a strategy to minimize your yearly tax bill if needed.