How to Know If It's a Good Time for a Roth IRA Conversion

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The Roth IRA is a top-tier retirement savings tool. For young people especially, it’s the best way to take full advantage of compound interest while minimizing your tax exposure. In the simplest terms, with Roth IRAs, you pay taxes on your savings now. This is compared to traditional IRAs, when you pay taxes later. We’ve written about the differences in more detail here, and I generally lean pro-Roth over traditional.

With Trump-era tax cuts set to expire in 2025, now might be a strategic time to take advantage of that “pay taxes now” element. Let’s explore whether a Roth IRA conversion could be the smart move for you.

Why consider a Roth IRA conversion now?

The Tax Cuts and Jobs Act of 2017 is set to sunset at the end of 2025, unless Congress extends it. If no action is taken, tax rates would revert to the higher levels of 2017 and earlier. This means that converting to a Roth IRA now, while tax rates are relatively low, could result in significant long-term tax savings.

Anyone with an existing retirement account, such as a 401(k) or traditional IRA, can convert to a Roth IRA. This option is available regardless of income levels, making it an attractive strategy for high-income earners who may not qualify for direct Roth IRA contributions. As always, a major draw of the Roth IRA comes down to future tax-free withdrawals. It’s a smart account for anyone who expects to be in a higher tax bracket down the line (which is most people).

Is a Roth IRA conversion right for you?

Regardless of the 2025 deadline, consider whether a Roth conversion is right for you.

۱. Current vs. expected future tax rates: If you anticipate being in a higher tax bracket in retirement, a Roth conversion may be beneficial.

۲. Time horizon: The longer you have until retirement, the more time your Roth IRA has to grow tax-free.

۳. Ability to pay taxes: Can you afford to pay the taxes on the conversion without using funds from the retirement account itself?

۴. Estate planning goals: Roth IRAs can be an effective tool for leaving tax-free assets to heirs.

What else to keep in mind

While a Roth conversion can offer benefits, it’s not without challenges.

۱. Immediate tax liability: The amount converted is treated as taxable income in the year of conversion, which could push you into a higher tax bracket now.

۲. Five-year rules: Roth IRAs have several “five-year rules” that require funds to remain in the account for a minimum period before becoming fully tax-free. This can complicate matters for those planning to access their retirement funds soon.

۳. Uncertain future tax landscape: Like I mention above, basing a significant financial decision on speculation about future government actions carries inherent risks.

For more, these are mistakes to avoid with your Roth IRA. Given the complexities involved in Roth IRA conversions, it’s advisable to consult with a financial advisor who specializes in retirement planning.

The bottom line

While the potential expiration of current tax rates in 2025 has brought Roth IRA conversions into the spotlight, it’s crucial to approach this decision carefully. A Roth conversion can offer significant benefits for some individuals, but it’s not a one-size-fits-all solution. By carefully considering your unique financial circumstances and seeking expert advice, you can make an informed decision about whether a Roth IRA conversion aligns with your long-term financial goals.

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