All about Roth conversions

Roth conversions can be an incredibly powerful tool in helping you manage and minimize taxes throughout retirement.

A Roth conversion is when you transfer (technically “convert”) money from a tax-deferred retirement savings account like a traditional IRA or 401(k) into a Roth version of that account.

Traditional tax-deferred accounts let you defer taxes on your contributions. In other words, you can take a deduction on your tax return for the amount of your contribution in the year of the contribution. Once contributed, any growth or income on the money in the account continues to not yet be taxed. You only pay tax on money you eventually take out of the account.

On the other hand, a Roth account is essentially the opposite tax treatment; you don’t get to deduct the money you contribute, but all distributions will eventually be tax-free (assuming you meet a few qualifying criteria; typically 1) being at least 59 ½ years old and 2) having your first Roth IRA be at least five years old).

In doing a Roth conversion, you have to pay taxes on the money you convert from the tax-deferred account into the Roth account. Why would you want to pay taxes now instead of continuing to defer them??? That’s a great question, and one that unfortunately doesn’t have a universally right answer.

Traditional logic is that it would be better to reduce your tax bill during your working years by deferring taxes until retirement, when you theoretically should have less income and therefore pay less in taxes.

However, traditional logic assumes your income will actually be lower. Furthermore, it assumes tax rates themselves don’t change. In reality, many people end up having MORE income in retirement and/or tax rates can indeed be higher in the future than they are today. This is the case now, as federal tax rates are generationally low and more likely to increase as opposed to stay the same or decrease going forward.

To help explain more about Roth conversions, how to do them, when they may make sense, pitfalls to watch out for, etc., I recently did a live video in my Facebook group, Taxes in Retirement, all about Roth conversions.