Experts: 7 Key Signs You Should Do a Roth Conversion

Jordan Rosenfeld
AJ_Watt / Getty Images
AJ_Watt / Getty Images

There are several types of retirement accounts that financial advisors recommend to save for retirement, including a 401(k) and Roth IRA. While you don’t get the upfront tax savings with a Roth that a 401(k) provides, you do get the benefit of tax-free withdrawals after retirement age.

Converting pre-tax funds into Roth funds can be a beneficial strategy under the right circumstances, but timing is a big factor in doing it well. Experts explain seven signs to look for that make a Roth conversion a good strategy.

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During the ‘Trough Years’

One of the best times for individuals to consider a Roth conversion is that sweet spot between retirement and when they begin collecting Social Security benefits, according to Christopher Stroup, CFP with Abacus Wealth Partners.

“This period is known as the trough years. It’s a window of time in which individuals have little income and the time is perfect for a Roth conversion.”

If You’re Laid Off

Additionally, Stroup said that a layoff is another good time to consider one. “Life may give you a lemon if you find yourself being laid off. That said, you can make lemonade out of this situation by executing a Roth conversion.”

A low- to no-income year is a window of time when you can take advantage of tax brackets because you’re in a lower tax bracket temporarily, which reduces the tax burden of a Roth conversion, he explained.

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If the Market Drops

A market drop presents another opportunity for a Roth conversion, Stroup said. “A significant market drop can present a toll on your account balances and mental state, but the bright side is that by doing a Roth conversion, you’re moving shares held at a discount into your Roth IRA,” he said.

This results in you paying less taxes on the conversion than you would have if you’d converted before the market dropped.

“Once the market rebounds, any withdrawal can be taken tax-free.”

If Your Tax Rates Are Lower Than Usual

Roth IRA conversions are typically most attractive in years when someone’s marginal and effective tax rates are low or at least lower than “usual,” according to Chris Urban, CFP, RICP and founder of Discovery Wealth Planning.

“Perhaps if a couple, one or both of you, moves to part-time work or retires, then this might be a good opportunity to convert pre-tax assets into Roth,” he said, adding that this is even more optimal if you can do this before starting Social Security benefits kick in, because there is typically an even greater tax advantage.

“Generally, this strategy tends to work well for folks in their late 50s and 60s but, of course, technically is available to younger folks as well.”

When Your Income Drops

Matthew Benson, CFP and owner of Sonmore Financial, a wealth management firm, offered two instances that would present opportunities for lower income:

  • Gap in income during working years: Many people experience a decrease in income during their working years due to lower incentive compensation, such as a bonus, or a job change that creates a gap in employment during the year, Benson said. “By converting funds during this period, you can minimize the tax impact.”

  • Lower income before reaching Social Security, RMDs and company pension: Right after retiring and before you begin to draw Social Security benefits, RMDs or a company pension, your income will likely be lower. “This can create a favorable window for Roth conversions, as you may have more control over your taxable income,” Benson explained.

“Everyone will tell you that tax rates are going up,” Urban added. “However, when people say this they are referring to federal marginal tax brackets, not your specific household effective tax rate.”

It’s a good idea to turn to a financial professional in assessing this timing, Urban recommended.

When It Will Reduce Taxes

Since a conversion increases your taxable income for the year, possibly affecting your tax bracket, eligibility for tax credits and deductions, it’s ideal to do it in a time when it will reduce taxes, according to John F. Pace, CPA and partner with Pace & Associates CPAs.

“During my tenure at Pace & Associates CPAs, we frequently navigated these scenarios, ensuring that the decision to convert aligns with broader financial planning goals and doesn’t inadvertently inflate clients’ tax liabilities for the year.”

When You Don’t Need To Take RMDs

“Roth IRAs offer no required minimum distributions (RMDs) during the owner’s lifetime, which provides a flexible, tax-free income stream in retirement and can be a profound estate planning tool,” Pace said.

He said that the ability to let assets grow over an extended period tax-free, and then pass these on to heirs tax-free, is a compelling argument for choosing Roth conversions amidst a broader estate planning strategy.

Create Synergy With Tax-Deduction Strategies

Whatever strategy you adopt, remember that Roth conversions accelerate income, which may result in higher tax liabilities, Benson stressed.

“Consider combining your conversion strategy with a tax-deduction strategy to counterbalance this effect. One effective method is to make charitable gifts and group them for multiple years using a donor-advised fund. By bunching deductions, you can reduce your taxable income and offset the tax impact of a Roth conversion.”

Consider Historical Tax Rates

In addition to comparing your current tax rates to your projected future rates, it is important to consider historical tax rates and trends, which can provide valuable insights into the current tax landscape and help you make informed decisions regarding Roth conversions, Benson said.

“As of 2023, tax rates are at 30-year lows, which presents a unique opportunity during a period of historically low tax rates. Roth conversions can be particularly beneficial. While it is impossible to predict the exact trajectory of tax rates, converting funds to a Roth IRA now would allow you to lock in the lower tax rates, potentially shielding your retirement savings from higher taxes in the future.”

By effectively navigating the complexities of Roth conversions and incorporating them into your retirement plan, you can optimize your financial situation and prepare for a more secure and tax-efficient retirement.

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