A Roth conversion moves money from a traditional IRA or 401(k) into a Roth IRA. You pay taxes on the amount converted now, in exchange for tax-free growth and tax-free withdrawals later.
The basic mechanics
When you convert, the converted amount is added to your taxable income for the year. Future withdrawals from the Roth, including the growth, come out without any additional tax.
When a conversion tends to make sense
Conversions are most attractive when your current tax rate is lower than what you expect to pay in retirement. That can happen in a year when your income is temporarily lower, such as early retirement before Social Security begins, or in a year after a business loss.
Things to watch for
A conversion increases your taxable income for the year, which can affect the taxability of Social Security benefits, Medicare premium brackets, and certain deductions and credits that phase out at higher income levels. The numbers should account for all of these, not just the headline rate on the converted amount.
What to do if you are considering one
The best time to think about a Roth conversion is before the year ends, when you still have time to make an informed decision. A projection of where your income will land for the year, combined with an estimate of your future tax situation, gives you what you need. If you would like to work through your numbers, we are glad to help.