When to convert to a Roth IRA 

A key part of retirement planning involves handling your clients’ Individual Retirement Accounts or IRAs. The question of converting from a traditional IRA to a Roth IRA is one that can inevitably arise. This is an important consideration which may have a significant effect on your client’s current financial standing and can impact their financial future.  

Knowing the right time and the right conditions to make a Roth IRA conversion can be crucial for your clients’ finances, since its tax benefits can differ from traditional IRAs or other non-Roth accounts.  

In this article, InvestmentNews discusses important information regarding Roth IRA conversions. We’ll go over what a Roth conversion is, how it differs from a traditional IRA, how it benefits account holders, and other relevant information.  

What is a Roth IRA conversion? 

The textbook definition of a Roth IRA conversion is simply this: it is the process of converting or moving funds from a traditional IRA or other retirement account (such as a 401(k), 403(b), or 457(b) plan) to a Roth IRA.  

Doing this conversion offers some benefits like tax-free growth on earnings on the account and other possible benefits.  

Why consider a Roth IRA conversion? 

For financial advisers, there are a few good reasons to recommend that their clients do a Roth IRA conversion. It offers great tax advantages, as well as other benefits:  

1. The Roth IRA account grows tax-free.  

This is probably the most attractive reason for making a Roth IRA conversion. The account owner’s contributions and the earnings on them are allowed to grow tax-free and may then be withdrawn tax-free once they reach the age of 59½. But this is assuming the Roth IRA account has been around for at least five years. 

2. Withdrawals from a Roth IRA can be tax-free.  

Unlike a traditional IRA, making withdrawals from a Roth IRA can be free of tax or penalties. This is true if certain conditions are met. The account owner must: 

• be aged 59½ years by the time of the withdrawal 
• have had the account for at least 5 years 
• withdraw with the intention of buying, building, or rebuilding their first home, with a lifetime maximum of $10,000. This benefit also extends to buying, building, or rebuilding a home for the account owner’s parents, children or grandchildren, if it’s also their first home.  
• have become permanently disabled 
• use the money as a hardship withdrawal – these can be of several types as determined by the IRS and are deemed exceptions to penalty taxes on early distributions. 
• use the money for Qualified Higher Education Expenses (QHEE) 
• be a qualified reservist in the U.S. Military and must be making a qualified reservist distribution 

Withdrawals from a Roth IRA are better than a traditional IRA. In a traditional IRA, your client would have to pay taxes on the money their investments earned, apart from any contributions that were deducted from their taxes.  

3. There are no age limits to making contributions.   

With the new rules on Roth IRA contributions, there is no longer an age limit to making contributions. For as long as you are earning, you can contribute to your Roth IRA; but take note of the contribution limits set by the IRS for the year.  

Your clients may even open a Roth IRA account for their children – known as a custodial IRA – if they have income.  

In addition, you can convert all or part of your existing funds in a traditional IRA to a Roth IRA, regardless of your income level.  

4. Beneficiaries can inherit more from a Roth IRA. 

If account holders convert all or some of the money of their non-Roth accounts into a Roth IRA, their heirs will surely benefit. If they inherit from a Roth IRA, they’ll receive tax-free withdrawals. Full stop.  

5. It’s possible to lower the tax bill with a Roth IRA.  

Converting your client’s account to a Roth IRA can give them the benefit of going down to a lower tax bracket when they retire. This is especially useful if you predict that they'll be earning less retirement or paying more taxes for the tax bracket your clients are in.  

6. There are no Required Minimum Distributions.  

Starting from 2024, the IRS mandates that there will no longer be any Required Minimum Distributions or RMDs. Roth IRA account owners do not have to take any withdrawals or distributions during their lifetime, if they choose. However, when the account owner dies, the beneficiaries of their Roth IRA become subject to the RMD rules.  

To help your clients understand Roth IRAs better, share this client information piece on Roth IRAs. Here, we go in depth into Roth IRAs, covering guidelines, withdrawal rules and penalties, and how to open an account.  

Who can contribute to a Roth IRA? 

Anyone who earns income can open and contribute to a Roth IRA account. However, there are certain restrictions to who can contribute to this type of account. For starters, those who have a Modified Adjusted Gross Income (MAGI) that is equal to or greater than the limits set by the IRS. 

For 2023, the following are restricted from contributing to their Roth IRAs: 

• individual taxpayers who have a MAGI of $161,000 or more 
• married couples filing jointly with a combined MAGI of $240,000  

When to make a Roth IRA conversion 

Although making a Roth IRA conversion can incur a tax bill, advising your client to go through the conversion process can provide more advantages. Here are some situations where a Roth IRA conversion is viable: 

1. Your client believes that they will have less revenues for the year 

If your client owns a business that didn’t turn a profit for the year and, worse, incurred a net loss, this is a perfect time to convert some funds. This can lessen the tax bill they’d have to pay for that year and help their business recover.  

2. If most of your client’s assets are in tax-deferred accounts 

By advising your client to convert to a Roth IRA, they can have assets that aren’t taxed when withdrawn. This can allow you to better manage their tax brackets and provide a more organized and personalized tax planning system for when they retire.  

3. Your client doesn’t need the funds for their retirement 

If your client has other sources of income and/or retirement funds, you can advise them to convert a sufficient portion or all these funds into a Roth IRA.  

That way, the funds can grow untaxed. If left undisturbed, the money can become a sizable tax-free inheritance for their heirs.  

4. You believe that your client will have to pay taxes from a higher bracket in the future 

Paying higher taxes may sound unusual, but it’s still a possibility. This is especially true if your client has yet to reach their peak earning capacity or has a long way to go before accumulating enough savings in their IRAs.  

Converting some funds into a Roth IRA from a traditional IRA would be a wise move in this case. Taxes are deferred until the funds are withdrawn, so they can grow tax-free. Paying the prevailing tax rate is better than paying higher taxes later when your client may no longer be working.  

You’re likely familiar with the saying, “timing is everything”. This saying also applies to making Roth IRA conversions. Is it better to do the conversion at the end of the year? At the beginning? Watch the video to find out.  

When not to make a Roth IRA Conversion 

On the flipside, there can be certain situations where a Roth IRA conversion would not be advisable. Here are some possible scenarios:  

1. Your client is on Medicare or taking Social Security benefits 

A Roth IRA conversion in this instance can potentially give your client more problems if they are on these benefits.  

Remember, a Roth IRA conversion is considered taxable income. This can mean more of their Social Security gets taxed and and/or increase their Medicare costs. 

2. Your client is retired (or close to it) and uses their IRA for living expenses 

Converting funds to a Roth IRA would also not be advisable. Money in a traditional IRA that they already use for day-to-day expenses may not be enough to take the tax hit. A conversion in this case could seriously impact your client's quality of life.  

3. Your client does not have enough money for the tax, or must sell off assets 

This is risky – not having a separate source of funds for paying the conversion tax means taking money from the IRA. That undermines the conversion.  

Your client’s other option would be to sell some assets, but this is likewise risky; the sale could give them more money than needed and force them to pay more taxes.  

Does a Roth IRA conversion make sense for your client? 

In some cases, a Roth IRA conversion can be a sensible move for your clients.  

In fact, financial planners recommend making multiple Roth IRA conversions spread over several years, a strategy that’s aptly named as the systematic Roth conversion plan.  

Roth IRA conversions can be good for your client if they have a significant amount in their traditional IRA, and a multi-year approach to their Roth IRA conversions is viable. (Yes, multiple Roth conversions are possible.) If executed correctly, this can make a large part of their retirement savings maximize their growth potential, while minimizing the impact of taxes.  

Crunch the numbers and see how you can convert enough of your client’s IRA funds. The idea is to prevent additional distributions from their traditional IRA from placing them into a higher tax bracket.  

In the early stages of your client’s retirement, a good strategy would be to advise them to convert their IRA to a Roth before the RMDs are due and their income declines. 

One item to look out for is to avoid Roth conversions within 2 years of your client filing for Social Security and Medicare.  

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