Why It Might Be Time to Consider a Roth Conversion

July 8, 2022

Saving enough for retirement is essential to ensure you can afford to support yourself when the time comes. But did you know that in addition to the amount you save, the way you save can make a big difference, too? That’s because your saving strategy can significantly impact your taxes.

If you’ve been saving for years in a tax-deferred account like a 401(k) or IRA and have built up a healthy nest egg — that’s great! But you may have a future tax problem. 

Fortunately, you also have an opportunity to reduce your potential tax burden with a bit of proactive planning. Converting some of your tax-deferred money to a Roth IRA now may reduce your future tax liability and give you a source of tax-free income in retirement.

Here’s how this process works and what to consider when determining if Roth conversions make sense for you.

What’s the Tax Problem?

Tax-advantaged retirement accounts provide you with a way to shelter your savings from taxes. While your money grows in the account, you’re not liable for the typical taxes that apply to the dividends, interest, and capital gains you earn. Therefore, your money can grow more quickly because those taxes aren’t dragging it down. 

However, just because you aren’t paying taxes upfront doesn’t mean you’re getting out of paying the IRS their piece of the pie altogether. Instead, you just defer taxes until you withdraw from the account in retirement. At that point, you usually owe ordinary income tax on the distributions.

This can be a concern because it means you may owe taxes at a higher rate on an even larger balance. 

On the other hand, Roth accounts offer a “pay now, save later” benefit, as you make qualified withdrawals tax-free. So, by converting some of your tax-deferred savings into a Roth IRA, you can avoid that compounding tax bill. Of course, you’ll have to pay taxes on the amount you convert; however, then it grows tax-free in the Roth IRA. 

It’s important to note that each conversion has a five-year waiting period before you can withdraw those funds without paying taxes on them.1

Understanding Required Minimum Distributions

Another important factor to consider is that the IRS requires you to take distributions from tax-deferred retirement accounts once you turn 722 — even if you don’t need the money. These required minimum distributions (RMDs) can limit your flexibility in planning your withdrawal strategy, and they can be tax-inefficient.

The formula is structured so you withdraw a portion of your account over your life expectancy. And the idea behind RMDs is to prevent people from using tax-deferred retirement accounts to avoid paying taxes. 

By April 1 after the year you turn 72, you must take a distribution equal to the amount of your account balance (as of December 31 the prior year) divided by your life expectancy, based on the appropriate IRS life expectancy table.3 For every subsequent year, you must take your RMD by December 31. 

Here’s an example of how it works:

Suppose you are 75 years old, and as of December 31 of last year your IRA balance was $2,500,000. You are married, and your spouse is not more than 10 years younger than you, so the Uniform Lifetime Table4 is the appropriate life expectancy table. It gives a life expectancy of 24.6 years for a 75-year-old.

Therefore, you would divide $2,500,000 by 24.6 for an RMD of $101,626. This means you must withdraw at least this amount from your account by December 31 of this year. And this amount is included in your taxable income, meaning you’ll have to pay according to your income tax bracket.

The chart below illustrates what your RMD would be at each age, assuming you start with $2,500,000 and earn 6% each year. Notice that the amount increases annually. Again, RMDs are designed so that you withdraw a portion of your balance over your life expectancy.

Chart, bar chart

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A Roth conversion could be beneficial because the same requirement does not apply to Roth accounts. In fact, there are no minimum distribution requirements for Roth accounts during your lifetime. 

In addition, Roth conversions can be an excellent tax-free wealth transfer vehicle because heirs can usually receive remaining Roth assets with no tax liability. In some cases, if you leave a Roth IRA to an heir other than your spouse or minor child, they may be required to withdraw the entire account balance within 10 years.5 Still, the withdrawals will typically be tax-free. 

When a Roth Conversion May Make Sense

Roth conversions are primarily about tax management. A Roth conversion may make sense if you currently have less taxable income than you expect to have later. This shifts your tax liability to when it’s more favorable to you.

Often, this means doing a series of conversions annually between the time you retire and before you start taking Social Security benefits and RMDs. This is likely when your taxable income will be the lowest, so your conversion will be taxed at the lowest rate possible.

Some people may think a Roth conversion is not worthwhile because they assume their taxes will be lower in retirement — but there are many reasons why that may not be the case. Don’t skip low-tax years in the early part of your retirement based on that assumption. Instead, take the time to do your own analysis or seek help from a retirement or financial professional. 

Is Now a Good Time for Roth Conversions?

The right time for Roth conversions ultimately comes down to your unique situation. However, there are several reasons why now might just be a good time to consider this financial move. 

First, as you may know, the market has not been kind to us in 2022. As of June, the S&P 500 is down more than 20%.6 While that might be painful, it potentially makes a Roth conversion even more valuable. That’s because your Roth conversion tax liability is based on the dollar amount you convert. So, the same number of shares that would have been worth $100,000 at the start of the year may only be worth about $80,000 now, so your tax bill for converting them will be lower.

If you convert these shares when the market is down, it gives you a great opportunity for tax-free growth. For example, if those shares that are now worth $80,000 bounce back to $100,000, then you will have gained that $20,000 tax-free! 

Next, think about our current tax environment. Thanks to the Tax Cuts and Jobs Act of 2017, our current income tax rates are some of the lowest we’ve had in the history of the income tax system. 

Bradford Tax Institute7

However, these tax cuts are set to expire in 2025.8 So, unless they’re extended, our income tax rates might revert to 2016 levels.

This provides a window of opportunity between now and the end of 2025 to shift your tax burden and take advantage of these lower rates.

Find Out If Roth Conversions Are Right for You

Roth conversions aren’t the right move for every circumstance. However, when done correctly, they can potentially save you thousands of dollars in taxes over the course of your retirement. 

If you’d like to explore Roth conversion strategies and learn whether they make sense for you, contact us today.

The commentary on this website reflects the personal opinions, viewpoints, and analyses of the Trinity Wealth Management, LLC employees providing such comments, and should not be regarded as a description of advisory services provided by Trinity Wealth Management, LLC or performance returns of any Trinity Wealth Management, LLC Investments client. The views reflected in the commentary are subject to change at any time without notice. Nothing on this website constitutes investment advice, performance data, or any recommendation that any particular security, portfolio of securities, transaction, or investment strategy is suitable for any specific person. Any mention of a particular security and related performance data is not a recommendation to buy or sell that security. Trinity Wealth Management, LLC manages its clients’ accounts using a variety of investment techniques and strategies, which are not necessarily discussed in the commentary. Investments in securities involve the risk of loss. Past performance is no guarantee of future results.


1What Is the Roth IRA 5-Year Rule?” Investopedia
2Required Minimum Distributions (RMDs),” IRS
3Publication 590-B (2021), Distributions from Individual Retirement Arrangements,” IRS
4Uniform Lifetime Table,” IRS
5Roth IRA Beneficiary Rules,” Investopedia
6What to know as S&P 500 enters bear market territory,” CNBC
7History of Federal Income Tax Rates: 1913 – 2021,” Bradford Tax Institute
8A Look Ahead at Expiring Tax Provisions,” Tax Foundation

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