Roth Conversion Strategy: When It May Make Sense and How to Evaluate It
A Roth conversion strategy means moving money from a pre-tax retirement account, such as a traditional IRA or 401(k), into a Roth account and paying income tax on the amount converted. You pay tax now so that future qualified withdrawals, including growth, may be tax-free. Done thoughtfully, it can give retirees and their families more control over taxes for decades. Done without a plan, it can create an unnecessary tax bill.
The question is not simply whether to convert, but how much, when, and how to pay for it. This guide covers how a Roth conversion works, when it may be worth discussing, and why the decision belongs in both your investment plan and your tax plan.
Start Here: A Complimentary Wealth and Tax Review
Compound offers a complimentary, no-obligation wealth and tax review that may include:
Your pre-tax balances: IRAs, 401(k)s, and other tax-deferred accounts
Projected income: wages, business income, Social Security, pensions, and future required distributions
Multi-year tax modeling: how conversions in different years may affect your taxes
Legacy goals: how account types may affect what heirs receive
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How Does a Roth Conversion Work?
When you convert pretax to Roth, the converted amount is generally added to your taxable income for that year and taxed as ordinary income. A few basics:
There is no income limit on conversions. Unlike direct Roth IRA contributions, conversions are available regardless of income.
Conversions cannot be undone. Once completed, a conversion generally cannot be reversed, so modeling before acting matters.
A five-year clock applies. If you are under 59½, converted amounts withdrawn within five years may be subject to an additional tax.
After-tax money is handled proportionally. If you hold both pre-tax and after-tax dollars across your IRAs, the pro-rata rule generally determines how much of a conversion is taxable.
Required distributions come first. In a year when a required minimum distribution applies, that amount generally must be taken before converting.
For a deeper explanation of the mechanics, see our guide to the convert pretax to Roth strategy.
What Is a Partial Roth Conversion?
A partial Roth conversion moves only part of a pre-tax balance in a given year. Many investors spread conversions across several years, converting an amount sized to keep taxable income within a target range. This approach may help avoid pushing income into much higher brackets in a single year and allows you to adjust as tax laws, markets, and your income change.
When a Roth Conversion Strategy May Make Sense
Every situation is different. These are circumstances where conversions are often worth evaluating:
Lower-income years
The years between leaving work and starting Social Security or required distributions can be a window of lower taxable income. Converting during those years may allow you to pay tax at lower rates than you might face later.
After a business sale or career change
Business owners often see a spike in income in the year of a sale, followed by years of lower earned income. Those later years may be worth reviewing for conversions. Read more about what happens after you sell your business.
Large pre-tax balances
If required distributions are projected to push you into higher tax brackets later, converting gradually may help reduce future required withdrawals.
Market declines
When account values are temporarily lower, converting the same number of shares results in less taxable income. Any recovery would then occur inside the Roth account.
Years with offsetting deductions or losses
Charitable gifts, business losses, or real estate deductions may create room to convert in a given year. Learn how some investors approach Roth conversions with real estate losses.
Legacy planning
Most non-spouse beneficiaries must withdraw inherited retirement accounts within a set period. Inherited pre-tax accounts can create taxable income for heirs during their own high-earning years, while qualified inherited Roth withdrawals are generally tax-free.
When a Roth Conversion May Not Fit
You expect a lower tax rate later. Paying tax now at a higher rate than you would in retirement may not be efficient.
You would need to pay the tax from the IRA itself. Using retirement funds to pay conversion taxes reduces what stays invested, and may trigger an additional tax if you are under 59½.
You need the money soon. The five-year rule and the time needed for tax-free growth to add up both matter.
You plan to leave the account to charity. Charities generally do not pay income tax on inherited pre-tax accounts.
Hidden Costs to Model
A Roth conversion raises your income for the year, which can affect more than your tax bracket. It may increase Medicare premiums in a later year, change how much of your Social Security is taxable, reduce eligibility for certain credits or deductions, and increase state income tax. For Wisconsin residents, conversions are generally subject to Wisconsin income tax as well. These effects are why a Roth conversion is best modeled across several years rather than one.
To see how a hypothetical investment may grow under different tax assumptions, try the Compound calculator. Results are hypothetical and for illustration only.
Why Conversions Need Both Wealth and Tax Planning
A conversion is a tax decision, but it is also an investment decision. What you convert, which assets you hold in the Roth afterward, and where the cash for taxes comes from all affect your portfolio. Compound brings wealth management and tax planning and preparation together so these choices are coordinated. For more, see why high income individuals may miss planning considerations without coordinated tax and wealth planning.
Compound works with individuals, retirees, and business owners throughout Wisconsin, including Milwaukee, Madison, Green Bay, Appleton, Waukesha, Janesville, and Eau Claire, as well as surrounding areas.
Wondering whether a conversion fits your plan? Request a complimentary wealth and tax review.
Frequently Asked Questions
What is a Roth conversion strategy?
It is a plan for moving money from pre-tax retirement accounts to Roth accounts over time, paying tax on converted amounts now in exchange for the potential of tax-free qualified withdrawals later.
Is a Roth conversion taxable?
Yes. The pre-tax amount converted is generally taxed as ordinary income in the year of the conversion, at both the federal and state level.
What is a partial Roth conversion?
It is a conversion of only part of a pre-tax account in a given year, often used to manage how much taxable income is created each year.
Can I undo a Roth conversion?
Generally, no. Conversions cannot be reversed once completed, which is why modeling the decision in advance is important.
When is the best time to do a Roth conversion?
There is no single answer. Lower-income years, market declines, and years with offsetting deductions are often worth evaluating with your tax and financial professionals.
Compound is a registered investment adviser. Registration does not imply a certain level of skill or training. This article is for informational and educational purposes only and should not be construed as personalized investment, tax, or legal advice. Federal and Wisconsin tax laws are complex and subject to change. Strategies discussed may not be suitable for everyone, and there is no guarantee that any strategy will achieve its objectives or reduce taxes. Calculator results are hypothetical, are not guarantees of future results, and do not reflect any actual investment. Investing involves risk, including possible loss of principal. Please consult your tax, legal, and financial professionals before acting on any information in this article. For more information, see Compound's Form ADV, available at adviserinfo.sec.gov.
About Compound Wealth
As financial situations become more complex, many individuals seek planning that considers more than one aspect of their financial life. Compound Wealth integrates tax planning, wealth management, accounting, and business transition services to help clients evaluate decisions within the context of their broader financial objectives.
