Are Roth IRA conversions a good idea?

Roth IRA conversions are a good idea for many people, but whether one makes sense for you depends on your current tax rate, your expected future tax rate, and how you plan to pay the tax bill.

The core trade-off is straightforward: you pay ordinary income tax on the converted amount today, in exchange for tax-free growth and tax-free withdrawals later. Conversions tend to work best when you expect your tax rate in retirement to be equal to or higher than it is now, when you have a temporarily low-income year to absorb the extra taxable income, and when you can pay the resulting tax bill from funds held outside the retirement account. Converting when your income is unusually high, or using IRA funds to cover the tax itself, often erodes the benefit significantly.

A few situations where a Roth conversion is frequently worth serious consideration:

• You are in a "gap year" between retirement and the age when required minimum distributions (RMDs) begin, giving you room to fill lower tax brackets with conversions before RMDs force larger withdrawals.
• You hold privately held assets inside a self-directed IRA or Solo 401(k), where a qualified IRA conversion appraisal can establish a defensible fair market value at the time of conversion, potentially locking in a lower taxable basis.
• You want to reduce future RMDs, which can otherwise push retirement income into higher brackets and increase taxes on Social Security.
• You want to leave tax-free assets to heirs, since Roth IRA distributions to beneficiaries are generally not taxable.

Conversions are less attractive if you are at peak earnings now and expect substantially lower income in retirement, or if you cannot comfortably cover the tax without touching the converted funds.

Before moving forward, it is worth running the numbers. Our IRA Conversion Tax Calculator can help you estimate the cost and long-term benefit of a conversion based on your specific situation.