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Roth IRAs – To Convert, or Not to Convert?

14 September 2022

We last discussed whether to roll your 401(k) plan into an individual retirement account (IRA) when you stop working for an employer. This week we discuss whether to convert your existing retirement account(s) into a Roth IRA.

An IRA, and most employer-sponsored retirement plans, allows you to contribute pre-tax dollars toward your retirement; for many, this is a good plan, as the applicable income tax rate for the retiree is often lower during their post-retirement lives than during their working years.

A Roth IRA employs post-tax contributions – which means that all withdrawals are free of income tax liabilities.

Top-tier income tax rates have dropped from 1980’s 70% to 37% currently, though proposals to increase that top rate are currently under consideration. While we do not foresee a return to anything like 70%, looked at realistically, income tax rates may well rise for top-tier earners.

It used to be that Roth IRAs, created in 1997, were only for those with income below a certain threshold, and that is true today with regard to opening or contributing to a Roth. In 2022, for example, to open a new Roth IRA or contribute to one, your income must be under $144,000 if single or $214,000 for married taxpayers who file jointly.

However, in 2010 the Obama Administration and the IRS eliminated all income limits on Roth conversions, and there’s currently no limit on the value of assets you can convert, though income tax will come due on the full amount converted to a Roth IRA.

Roth conversions are not for everyone under any and all circumstances, as these conversions represent taxable events, meaning you will owe income tax on the entire amount of assets converted.

However, if you are more than 5 years away from retirement, have a high income and a healthy balance in your tax-deferred IRA, and either expect your income tax rate to rise in the coming years, a Roth conversion of all or part of your retirement assets might be for you, especially if you have funds outside of your IRA to pay the tax.

Upsides Include:

  • Distributions from a Roth IRA after age 59 ½ are tax-free, as Roth IRAs are funded with post-tax dollars, unlike tax-deferred IRAs. The only caveat is that when you’ve converted pre-tax retirement funds to a post-tax Roth, the assets must be held in the Roth IRA for five years before they can be withdrawn. Earlier withdrawal of these funds results in a 10% tax penalty. Distributions are also tax-free to certain beneficiaries, such as your spouse, for their lifetime, and for other beneficiaries, such as your children, for 10 years. If the children are minors when they inherit, the 10-year timeline begins when they reach the majority.
  • If you don’t need the income after you retire, as the original owner of the Roth IRA you are not required to take minimum distributions (RMDs), unlike tax-deferred IRAs from which RMDs must be taken starting at age 72, with a hefty 50% penalty if you don’t. So, you can effectively make a tax-free gift of a Roth IRA to your heirs in entirety if you so choose.
  • Converting to a Roth IRA can reduce your estate taxes by the amount of income tax you paid in connection with the conversion. Given that the current Administration has proposed significantly reducing the current estate exemption from its current $12.06 million for individual tax filers ($24.12 million for married taxpayers who file jointly), this estate tax reduction may be significant for yourself and your heirs. It is true that the current estate exemption could drop significantly if Congress doesn’t take action by 2025. However, historically there has rarely been sufficient Congressional enthusiasm for a reduction in the estate exemption – it has been reduced twice only since its creation for tax year 1916 – dropping from $100,000 to $50,000 for 1932, and from there to $40,000 for 1935.

Downsides Include:

  • The most obvious downside to Roth conversions is that you will have to pay income tax on the full amount of retirement assets converted. However, if you are considering converting to a Roth IRA, it might make sense to do it sooner rather than later – not only because your income tax rate might rise, but also because your 5-year clock on holding the assets before distribution will start earlier.
  • Since the full amount of the assets converted is considered as taxable income in the year of conversion, you could end up in a higher income tax bracket and pay more in taxes on all your income for that year – assuming you aren’t already in the highest bracket. We recommend you consult closely with your CPA/financial planner when considering a Roth conversion so that no aspect of the conversion’s potential impact comes as an unwelcome surprise.
  • If you have a blend of tax-deferred and after-tax contributions and more than one IRA, the taxing on the conversion becomes complicated, requiring the determination of the ratio of after-tax contributions to tax-deferred contributions. The resulting percentage is counted as taxable income. Again, work with your CPA/financial planner on this well in advance of actually making a Roth conversion.

If you are considering converting some or all of your retirement assets to a Roth IRA, and want to understand how this could potentially affect your income tax liabilities, please click here to email me directly – I am here to help.

Until next time –



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