Is Converting a Traditional IRA to a Roth Worth It?

Many adults invest in an Individual Retirement Account (IRA). If this includes you, you may have chosen a traditional IRA as part of your retirement planning. IRA assets can play a big role as part of your retirement savings, along with Social Security, workplace 401(k) accounts and other investments.

Because Roth IRAs offer great tax benefits, you may be wondering if converting funds from a traditional IRA to a Roth IRA would be a smart decision for you. Let’s take a look.

Fundamental differences: Traditional IRA vs. Roth IRA

First, make sure you understand the tax advantages—and the tax consequences—to both types of IRAs. A Roth IRA offers a different set of tax implications than a traditional IRA.

Paying taxes on a Roth IRA conversion

If you have a traditional IRA but like the idea of tax-free growth and withdrawals that come with a Roth IRA, you might consider converting your account. But before you do, be aware that you’ll have to pay taxes on that money since you didn’t pay taxes on it when you first contributed. And, the taxes on funds converted will be due in the tax year of the conversion.

If you’re 73 years old, you’ll have to take an annual Required Minimum Distribution (RMD) from your traditional IRA. This threshold was raised from 72 to 73 with the passage of the SECURE 2.0 Act in 2023. Taking RMDs is necessary every year, and you’ll have to take that distribution before you can convert the funds. You’ll pay taxes on the RMD as ordinary income as well.

These tax payments may give you pause. But depending on your situation, it may be worth it to pay now and then reap the tax benefits later.

A traditional-to-Roth IRA conversion may make sense if:

• You’ll have low income or no other income in the year you’re converting. If you’re in a lower income tax bracket because of a layoff or time away from the workforce, then converting now could save you money because you’ll pay less in taxes while your tax rate is lower. You don’t have to convert the entire balance—you can convert any amount you choose.
• You’ll retire in a higher tax bracket. No one knows for sure what tax rates will be in the future. If you believe yours will be higher after you retire, it may make sense to pay tax on the money now. That way, you can avoid paying a higher tax rate on withdrawals when you’re retired.
• You want to pass tax-free money to heirs. Beneficiaries who inherit your Roth IRA won’t have to pay federal income tax on the withdrawals if the Roth IRA account has been open at least 5 years. If it has been open for a shorter period, they’ll owe tax with no penalty.
• The value of the investments in your traditional IRA has fallen considerably. If the value of your IRA investment has taken a huge dip due to market fluctuations, volatility or recession, a lower IRA account value could be a good time to consider a Roth IRA conversion.

A traditional-to-Roth IRA conversion may not make sense if:

• You’re likely to need the money within 5 years. If you’re nearing retirement and expect to make withdrawals within 5 years, you’ll probably want to keep the traditional IRA. Withdrawals from a Roth IRA are only tax-free if you’re 59 1/2 years old or older and have held the account for at least 5 years. If you withdraw the money sooner, you’ll not only end up paying tax, but you’ll also pay a 10% early withdrawal penalty. Plus, if you need to use money from the IRA to pay the conversion taxes, you’ll lose all future earnings on that amount.
• You expect your tax rate to drop. If you expect to have a lower tax rate when you retire, then converting might cost you more in taxes now than you’d save with tax-free withdrawals later. Look at your tax bracket now and consider what it may be in retirement before you decide to go through with the conversion.

Roth IRA and traditional IRA accounts both have benefits that you should look at as part of your estate planning. If you still need some guidance, a tax advisor can help you walk through these scenarios in greater detail.