Pros and Cons of Converting a Traditional IRA to a Roth IRA
Converting a Traditional IRA to a Roth IRA can be a smart financial move in the right circumstances, but it’s important to weigh the pros and cons before making the switch.
Roth IRA funds are currently not means-tested or taxed. Contributions are made with after-tax dollars, and qualified withdrawals—both contributions and earnings—are tax-free if you’re at least 59½ and the account is at least five years old. Exceptions may apply for first-time home purchases, disability, or death. While current rules are favorable, future tax treatment could change, so it’s important to stay updated on potential law changes.
Let’s look at Pros and Cons as well as a couple of examples:
Pros:
- Tax-Free Growth and Withdrawals:
Once funds are in a Roth IRA, all future growth and qualified withdrawals are tax-free. This is especially beneficial for younger individuals or those expecting higher tax rates in retirement. - No Required Minimum Distributions (RMDs):
Roth IRAs are not subject to RMDs during the account owner’s lifetime, allowing funds to grow tax-free for a longer period and providing more flexibility in retirement planning. Conversely, for a regular IRA you must start taking required minimum distributions (RMDs) April 1, of the year after you turn age 73 (for those turning 73 in 2023 or later). - Estate Planning Advantages:
Because there are no RMDs, a Roth IRA can serve as an effective estate planning tool, enabling beneficiaries to inherit a tax-free asset that can continue to grow.
Cons:
- Immediate Tax Liability:
The biggest downside is the income tax due on the amount converted. If you convert $100,000, that entire amount is added to your taxable income for the year which could mean you move to a higher tax bracket. - Impact on Other Taxes and Credits:
A large conversion can affect Medicare premiums (IRMAA), the taxation of Social Security benefits, and eligibility for tax credits or deductions. - Cash Needed to Pay Taxes:
Ideally, taxes on the conversion should be paid from outside funds. Using IRA funds to pay taxes reduces the amount that gets to grow tax-free and may trigger early withdrawal penalties if you’re under 59½. - Market Timing Risk:
If the market drops soon after the conversion, you’ve paid tax on a higher value than the account is worth.
Good Example for Roth Conversion:
Suppose Jane, age 60, recently retired and expects little to no taxable income this year. She hasn’t yet started Social Security or pension payments, and she doesn’t need to tap her IRA yet. This creates a temporary “low income” window where she’s in the 12% tax bracket. Jane could convert $50,000 from her Traditional IRA to a Roth IRA and pay tax at a lower rate than she expects to face in the future. This strategy helps her reduce future RMDs and build a pool of tax-free retirement income.
Bad Example for Roth Conversion:
Now consider Mike, age 63, who is still working and earning a high salary. He’s also receiving Social Security and is enrolled in Medicare. If Mike converts $100,000 from his Traditional IRA this year, the added income pushes him into the 32% tax bracket, increases the taxable portion of his Social Security, and triggers higher Medicare premiums. He also doesn’t have enough cash on hand to pay the tax bill, so he uses part of the IRA distribution to cover taxes—reducing the amount that ends up in the Roth and potentially incurring a 10% early withdrawal penalty if he’s under 59½. In Mike’s case, the conversion creates a hefty tax bill and adds complexity without a clear long-term benefit.
In general, it’s hard to see a clear benefit for an older, higher-income taxpayer. There could be an application where there is a substantial drop in the market value of securities held by the taxpayer. Even then, without a clear plan and benefit probably will not work paying the tax.