As retirement approaches, many people begin to wonder: Will taxes take a bigger bite out of my savings than I expect? After years of diligent saving, the idea of handing over a large portion of your nest egg to the IRS can feel discouraging. That’s why strategies like a Roth conversion have become so widely discussed among retirees and pre-retirees. At its core, this move can help shift the timing of your taxes, allowing more of your money to work for you later in life.
Why It Matters
IRAs, whether traditional or Roth, are powerful tools for retirement savings. With a traditional IRA, contributions may be tax-deductible, but withdrawals in retirement are taxable. Roth IRAs flip the equation: you contribute after-tax dollars, but future qualified withdrawals are tax-free. For someone entering retirement, that tax-free growth can be especially valuable. The challenge? Not everyone qualifies to contribute directly to a Roth, and tax brackets can make a big difference in what you ultimately keep. A Roth conversion helps bridge that gap.
A Roth conversion allows you to move funds from a traditional IRA into a Roth IRA. You’ll likely owe taxes in the year you make the conversion, but afterward, withdrawals, if rules are followed, are tax-free. For retirees and pre-retirees, the question becomes: when is paying those taxes most advantageous?
Two Common Scenarios
Scenario 1: Converting to a Low-Income Year
Think about the years between when you stop working and before Social Security or required minimum distributions (RMDs) start. During this time, your income may be much lower. A lower income usually means a lower tax bracket, which can make it a good time to move money from a traditional IRA to a Roth. Paying a smaller tax bill now could mean more tax-free income later when you’ll likely need it most.
- For example, if you had $10,000 in a traditional IRA and your tax rate dropped to 20% for the year, converting would cost you $2,000 in taxes today. But over 30 years, that money could grow to nearly $46,000 tax-free in a Roth. If you left it in the traditional IRA and later paid a 40% tax at withdrawal, you’d keep only about $34,000. (Assuming a long-time horizon and a steady rate of return, but actual market results may vary).
Scenario 2: The “Backdoor Roth” for High Earners
Some people earn too much to put money directly into a Roth. A “backdoor Roth” is a workaround: you add money to a traditional IRA without taking a deduction, then convert it to a Roth. This way, the money can still grow tax-free, potentially.
- For example, putting $7,000 into a Roth through this method and letting it grow at 6% a year for 30 years could potentially give you over $40,000 tax-free. The same $7,000 in a regular investment account might end up closer to $35,000 after taxes on the gains. (Assuming a long-time horizon and a steady rate of return, but actual market results may vary).
When It Might Not Be the Right Fit
A Roth conversion isn’t always ideal. If you’re within five years of needing the money, the IRS’s five-year rule may limit penalty-free access to earnings. And if you don’t have cash on hand to cover the taxes triggered by the conversion, you could end up reducing your retirement savings rather than enhancing them.
Looking Ahead
Ultimately, a Roth conversion is about control: would you rather pay taxes now at a potentially lower rate, or risk paying more later when withdrawals and RMDs increase your taxable income? For retirees and pre-retirees, this decision often comes down to balancing tax efficiency with income needs.
What role will taxes play in your retirement story? How might your income sources shift over time? These questions can help frame whether a Roth conversion deserves a place in your plan.
If you’re weighing these possibilities, consider discussing scheduling a complimentary meeting with us. Sometimes, one well-timed decision can make the difference between uncertainty and clarity in retirement.
Source:
(1) Fukawa, Leotie. “Is a Roth Conversion Right for You?” Wealthfront Blog, 5 Feb. 2025, www.wealthfront.com/blog/roth-ira-conversion/
For more complete information about your 401(k) investment options, call your company’s plan administrator or your financial professional for a prospectus. The prospectuses contain details on investment objectives, risks, fees, and expenses, as well as other information about your plan’s investment options, which you should carefully consider. Please read the prospectuses thoroughly before sending money. Roth accounts require the owner to be 59.5 years old and have had the account open for 5 years to take penalty-free withdrawals. Investing involves risk, including possible loss of principal. No investment strategy can ensure financial success or protect against losses. This information is being provided only as a general source of information and is not intended to be the primary basis for investment decisions. It should not be construed as advice designed to meet the particular needs of an individual situation. Please seek the guidance of a financial professional regarding your particular financial concerns. Consult with your tax advisor or attorney regarding specific tax issues. We do not provide tax or legal advice or services. Always consult with qualified tax and legal advisors concerning your own circumstances.
