When Roth Conversions Actually Make Sense

By: Michael Carbone, CFA, CFP®

Any individual has the ability to move an unlimited amount of dollars traditional pre-tax retirement dollars (Traditional IRA, SIMPLE IRA, SEP, other pre-tax retirement plans, etc.) into a tax-free Roth account. This is known as a Roth conversion – and by doing so, the investor is choosing to pay income taxes on the money today, as opposed to when the money would have otherwise been withdrawn in retirement.

Although this may seem like a pretty good deal considering that all of the future growth on this money would be tax-free – it’s important to understand what needs to happen for you to actually benefit more over the long-run.

The conventional wisdom is, “if you expect to pay a lower marginal income tax rate today then when you’re retired, a Roth conversion may benefit you”. And this is generally true from a mathematical standpoint; however, it’s also important to understand it’s potential flaws:

  1. It’s impossible to know how tax laws may change over time, and
  2. This assumes the “converter” will eventually spend the money – as opposed to their beneficiaries

So, when do Roth conversions actually make sense?

If you’re motivation behind the conversion is to maximize personal wealth, I believe it often makes sense to move money from a pre-tax account into a Roth account when you're confident that your current marginal tax rate is significantly lower than what you’ll face in retirement. While it might appear that you're simply banking on future tax rates going up, the decision involves more nuanced considerations, particularly regarding changes in your income once you’re retired.

The U.S. federal income tax system operates on a progressive scale, meaning that higher levels of income are subject to higher marginal tax rates. As a result, most retirees typically find themselves in a lower tax bracket compared to when they were actively working. This is because retirees no longer earn regular wages and instead rely on withdrawals from their investment portfolios for income - resulting in lower taxable income.

In essence, a Roth conversion can make sense if you anticipate that your current tax rate is notably lower than what you'll encounter in retirement, based on what your income will be at that time.

If you’re motivation behind the conversion is to maximize the future inheritance you leave your children, I believe a Roth conversion can be a strategic move when:

  • You're confident that your current marginal tax rate is significantly lower than what your beneficiaries be taxed when distributing the funds, and
  • You’re confident you won’t need the money for spending in retirement

The potential benefits of doing a Roth conversion for this purpose can be even more challenging to understand. Why? Because current law requires non-spousal beneficiaries to distribute inherited retirement funds over a 10-year period. So, if your beneficiaries inherit a large sum of pre-tax IRA assets, they’ll be forced to distribute those funds over a 10-year period. If they’re already earning a reasonable wage at the time, these distributions will sit on top of their own wages (for tax purposes) and may be taxed at considerably high rates. This would make the case for Roth conversion even more compelling.

In summary, converting pre-tax dollars to Roth can be highly beneficial in specific situations. However, the ideal choice may not always be straightforward. So, it's crucial to anticipate and evaluate whether this strategy aligns with your future financial expectations.

If you feel that you’d benefit from a second opinion of your retirement goals – answer a few questions to see if you may be a good fit for a complimentary consultation.

I wish you the best of luck and hope to hear from you soon!


Important Disclosures
Securities offered through Raymond James Financial Services, Inc. Member FINRA/SIPC. Investment advisory services are offered through Raymond James Financial Advisors, Inc. Eppolito Financial Strategies, LLC is not a registered broker/dealer and is independent of Raymond James Financial Services.
Financial and investment planning inherently involve potential tax and legal implications, with which we are generally familiar. We do not, however, practice as lawyers or CPAs and cannot give specific legal or tax advice. You should always consult with your tax advisor, or your attorney, when making complicated legal or tax decisions, however, we’re glad to work with your tax or legal professional to help you meet your financial goals. Raymond James financial advisors do not render advice on tax or legal matters.
Any opinions are those of Michael Carbone - not necessarily those of Raymond James. The foregoing information has been obtained from sources considered to be reliable, but we not guarantee that is accurate or complete. Expressions of opinion are as of this date and are subject to change without notice. Investing involves risk and you may incur a profit or loss regardless of strategy selected.