Should I Do a Roth Conversion?

Lori FlandersFinancial Planning, Retirement, Retirement Planning

By Brian Fricke

You’re looking forward to a worry-free retirement now more than ever—but is your savings ready to foot the bill? 

When it comes to retirement savings, tax implications often drive our decisions; IRAs (individual retirement accounts) are no different. Both a traditional IRA and a Roth IRA come with a tax benefit, and it’s vital to understand the differences between the two before deciding if a conversion is right for you.

Each type comes with differing tax benefits, penalties, eligibility, and rules. Let’s go over the differences between a traditional and Roth IRA, what a conversion is, and help determine if you could benefit. 

Traditional vs. Roth IRA

A traditional IRA provides a tax benefit on the front end, meaning qualifying individuals enjoy a benefit sooner rather than later. Contributions are made with pre-tax money. Come tax time, the contributions made over the last year are fully or partially tax-deductible based on income and whether you or your spouse is covered by a work-sponsored retirement plan. 

Here’s a breakdown based on tax filing status:

  • Single: The tax deduction phases out for incomes ranging from $66,000 to $76,000.
  • Married: The tax deduction phases from $105,000 to $125,000 for the spouse making traditional IRA contributions with a work retirement plan.
  • Married: The tax deduction phases out from $198,000 to $208,000 if the contributing spouse is not covered by a workplace retirement plan and the other spouse is covered. (1)

The max annual contributions into a traditional IRA is $6,000 (or $7,000 for those over 50). (2) A traditional IRA also comes with a required minimum distribution (RMD) once you turn 72 years old. Ignoring the RMD will land you a hefty penalty fee. (3)

On the contrary, a Roth IRA provides a tax benefit once you’re ready to withdraw the funds. The money you fund your Roth account with is taxed prior to depositing. When it’s time to cash in, you will not be assessed any further taxes on the initial investment or the gains.  

Unlike a traditional IRA, there is no required minimum distribution associated with a Roth IRA. You may also withdraw contributions at any time. But be careful to not withdraw any of the gains before you’re 50½ years of age to avoid a 10% penalty fee. (4)

Roth IRA Conversion and Taxes

A Roth IRA conversion is when you move funds from a traditional IRA into a Roth IRA. In the case of a Roth IRA conversion, you’re ultimately deciding the tax benefits of the Roth are superior to a traditional IRA, based on your financial scenario.

But how is that determined? Consider the tax bracket you are in today. Now take a moment to consider which tax bracket you may be in when it’s time to retire. Would you rather pay taxes at today’s rate? Or the anticipated rate of the future? Answering these questions is the simplest way to determine if a Roth IRA or traditional IRA better suits you.

Is a Roth IRA Conversion for You?

If you have a traditional IRA but believe you’ll ultimately be in a higher tax bracket once you’re ready to withdraw your funds, then a conversion may be for you. 

Remember, the contributions made into a traditional IRA have not been taxed; so when you convert, you will be required to pay taxes on everything coming out of the traditional IRA before it’s deposited into the new Roth IRA.

With the taxes paid, the conversion can occur. Your funds can now grow tax-free regardless of how high you climb up the tax bracket ladder. The primary goal of a Roth IRA conversion is to lower your tax bill in the future. 

What About Income Eligibility Caps?

There are income caps associated with who is or is not able to contribute to an IRA. Here’s a summary of Roth IRA eligibility based on your modified gross income:

Single Tax Filing Status:

  • $125,000 or less: You can contribute the maximum limit. 
  • $125,000–$140,000 range: You can contribute a reduced amount.
  • Over $140,000: Not eligible (5)

Married Tax Filing Status:

  • $198,000 or less: You can contribute the maximum limit. 
  • $198,000–$208,000 range: You can contribute a reduced amount.
  • Over $208,000: Not eligible (6)

What if you see yourself in a higher tax bracket in the future but you’re not eligible to contribute to a Roth IRA? Is there a way to still take advantage of the Roth account tax benefit? At first glance, it may seem as if you’re out of luck. But in reality, there are no income limits associated with a Roth IRA conversion

Backdoor Roth IRA

A backdoor Roth IRA is a work-around for those that exceed the income limits associated with a Roth IRA but are interested in the tax benefit. The process includes depositing money into a traditional IRA and using the “no income limits” Roth IRA conversion. 

During the process, you will have to pay taxes on the contributions and gains to complete the transaction, but you will reach our goal of watching your funds grow tax-free into the future. For the little bit of added effort, you receive your reward upon retirement when you withdraw funds with no tax implications.

We suggest taking a close look at your retirement accounts, current tax brackets, and expectations for the future.

Still Have Questions?

It’s expected to have questions related to which retirement account is best for you, and anything related to taxes can get confusing in no time. But remember that you don’t have to make these decisions on your own. 

We at Financial Management Concepts can help you determine if a Roth conversion is the right fit for you and help you implement the process. Take the first step toward your version of an Incredible Retirement® by scheduling a free 20-minute discovery call today. Request a free copy of my book: Worry Free Retirement—Do What You Want, When You Want, Where You Want.

About Brian

Brian Fricke, CFP® is the President and Founder of Financial Management Concepts, a Fee Only® retirement planning and investment management firm. Brian has over 30 years of experience in retirement planning and investment management.

Brian is also the author of Worry-Free Retirement and a book specifically for Lockheed Martin employees, Safe Landings: How Lockheed Martin Employees Can Avoid the Turbulence That Can Crash Retirement.

Using FMC’s 3-step Financial Roadmap® process, Brian helps his clients sleep better at night, relieved of the stress and worry of running out of money in retirement.

Brian serves as the Investment Committee Chair of the LCMS Foundation and is on the Board of Trustees of the New Smyrna Beach Firefighters pension fund. When he’s not working, he enjoys surfing, paddle boarding, and traveling with his wife, Annette, and he is the proud father of two grown sons, Adam and Justin (who is married to daughter-in-law Chelsea). Brian and his sons epitomize the “worry-free” lifestyle by traveling to different countries with friends on their annual father-son surf trips. To learn more about Brian, connect with him on LinkedIn.