When Is It Best To Do A Roth Conversion?

When Is It Best To Do A Roth Conversion?

May 10, 2024

First, let’s define what a Roth is vs a Traditional IRA. Traditional Individual Retirement Accounts (IRAs), which were created in 1974, are owned by roughly 41 million U.S. households. And Roth IRAs, created as part of the Taxpayer Relief Act in 1997, are owned by nearly 32 million households. Both are IRAs. And yet, each is quite different.

Up to certain limits, traditional IRAs allow individuals to make tax-deductible contributions to their account(s). Distributions from traditional IRAs are taxed as ordinary income, and if taken before age 59½, may be subject to a 10% federal income tax penalty. Generally, once you reach age 73, you must begin taking the required minimum distributions.

Contributions to a Roth IRA are made with after-tax dollars. To qualify for a tax-free and penalty-free withdrawal of earnings, Roth IRA distributions must meet a five-year holding requirement and occur after age 59½. The benefit of a Roth is that it grows tax free but annual contributions are no longer deductible as with a Traditional IRA if still contributing.

Should I do a Roth conversion? So, it depends a lot on what you plan on doing with these funds. For example, if you’re planning on creating a retirement income stream immediately and you do a Roth conversion, you'll have less principal to worth with after taxes in creating that income initial income stream. One of the best times to convert Traditional IRA dollars to a Roth is during what I refer to as “the trough years” – the period after you've retired but before you collect Social Security benefits, or you're subject to the required minimum distribution rules.

During this period your income tax bracket is usually lower compared to when you were working. If you’re just planning on leaving a legacy to your beneficiaries, then it might be wise to get Uncle Sam out of the way now vs down the road. It’s always wise to do a Roth conversion analysis with a qualified financial advisor taking your whole financial situation into consideration before doing a conversion.  

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