When Does a Roth Conversion Make Sense?

If you have money in a traditional IRA, there are several instances when it might make sense to consider a Roth conversion. That’s because a Roth conversion allows you to pay tax today, locking in what you owe Uncle Sam while avoiding any subsequent taxes on that money now and in the future. If you want to minimize taxes today and pay them later, it makes sense to use a traditional IRA. But in many cases, it’s beneficial to flip this around and pay taxes now by converting to a Roth.  

So, when does a Roth conversion make sense? Here are some key times to consider one. 

Consider a Roth conversion when you're young

When you’re younger, you’re typically earning less and are therefore in a lower tax bracket than you will be as you get older. That makes it a good time to convert because you’ll pay tax at a lower rate today than when you reach a higher tax bracket later. In addition, you have the power of time to help the funds that you do convert compound before you will use them in retirement. 

Consider a Roth conversion if your income dips

If you have an unexpected dip in income, converting traditional IRA funds to a Roth and paying the tax is probably not your top priority. But a salary dip in a given year can be a nice opportunity to convert and pay the tax while you’re in a lower tax bracket. 

For instance, let’s say you have $50,000 in a traditional IRA and you’re in the 24 percent tax bracket. Converting would cost you $12,000 in federal tax. But if your income falls to the 12 percent tax bracket in a given year, you would pay half the tax and save $6,000.  

Consider a Roth conversion before the tax brackets go up

Current tax rates will expire at the end of 2025 if lawmakers don’t extend them. No one knows what will happen in Washington, but we know right now that tax brackets are pretty low compared to what they have been historically. That means you can convert now and save in taxes before rates potentially go back up years from now. 

Consider a Roth conversion when the market dives

Market corrections are just part of the territory when you’re investing. While it can be painful to watch the value of your investments plummet, such a situation can be an excellent opportunity to convert IRA funds to a Roth. That’s because you’re taxed on the market value of your conversion. If your $50,000 investment falls to $40,000, you’ll only pay tax on $40,000. Then, when the markets recover, you’ll no longer owe any tax on those subsequent investment gains. 

One additional option is to open an annuity to accumulate funds for retirement. The money will grow tax deferred and can be used in the future to create a guaranteed stream of income in retirement that you can’t outlive.