If most of your retirement savings sit in a traditional IRA or 401(k) plan, a withdrawal strategy in retirement can be crucial. That money probably hasn’t been taxed yet, and since withdrawals generally count as taxable income, it could result in some inadvertent surprises – namely, pushing you into a higher tax bracket and costing you more tax overall.
A Roth conversion shifts that tax bill into the year you convert, which can mean you won’t be subject to taxes on qualified withdrawals in retirement. But is a tax bill now worth the payoff in the future?
Before committing to a Roth conversion, a financial advisor can help you weigh your options. Start your search with NerdWallet Advisors Match.
How a Roth Conversion Affects Your Tax Bracket
A Roth conversion moves money from a pre-tax retirement account, such as a traditional IRA or 401(k), into a Roth IRA. If that money hasn’t been taxed yet, as is often the case, the conversion can trigger a taxable event 1.
Here’s what that could mean:
Now, in the present: The amount you convert generally counts as income in the year you convert. Depending on the conversion amount and your current income, it could push you into a higher tax bracket for that year.
Later, in retirement: There are two signature advantages with a Roth IRA: qualified withdrawals in retirement are tax-free and the account doesn’t have required minimum distributions (RMDs) during your lifetime 2. That’s in contrast to traditional retirement accounts. For those, withdrawals are taxed (since contributions went in pre-tax) and RMDs are mandatory starting at age 73 or 75, depending on your year of birth 3.
Is It Worth Paying Taxes Now For a Roth Conversion?
It can be, but a worthwhile Roth conversion hinges on a few factors. If the tax rate you’re in currently is lower than the tax rate you expect to be in retirement, a conversion may make sense. But if you don’t have cash on hand to pay for the conversion, and plan to use part of the conversion to pay taxes, that answer can change.
A Roth conversion also can’t be undone once complete. With that in mind, it could be an expensive mistake to finalize a conversion only to realize that the tax bill is higher than expected, or the pay off in retirement isn’t what you thought it might be.
With a financial advisor’s help, you can test a conversion before you commit. They can help you think through strategies including:
Converting in a low-income year. A job change, gap in employment or smaller bonus could put you in a lower tax bracket, which can reduce the cost of conversion. While this is the easiest to determine on your own, you can also discuss future income changes with a financial advisor.
Converting when the market is down. A smaller balance generally means a lower tax impact. An advisor who also offers investment management for their clients is likely tuned into market movements and can help you decide timing.
Choosing when in the year to convert. Whether you pay estimated taxes throughout the year or during tax season could affect your conversion timeline. An advisor could offer more personalized insight on the best timing for you.
Whether to spread the conversion over multiple years. There’s no rule that says you have to do your conversion all at once. An advisor can help think through whether it’s worthwhile to do what’s called a Roth conversion ladder, where you stagger conversions over multiple years.
The value of advice
Preretirees with a formal retirement plan tend to be over 2× to almost 4× wealthier than those without one.
Source: T. Rowe Price, “Survey reveals the rising importance of financial planning at retirement,” March 2024 (2023 Retirement Savings and Spending Study). This reflects an association observed in the survey; it does not show that having a financial plan caused the difference in wealth.
Ready to Plan Around Your Tax Bracket?
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