Converting money from a traditional IRA or 401(k) into a Roth IRA means paying taxes up front in exchange for tax-free withdrawals later. And in some situations, that makes sense.
If you're going to do a Roth conversion, it's important to weigh the benefits against the near-term tax bill. But if these signs apply to you, a Roth conversion could be a very smart idea.
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1. You expect to land in a higher tax bracket later on
There are plenty of reasons you could end up in a higher tax bracket as a retiree than right now. If you've been saving well for your senior years, for example, and expect large withdrawals from your savings, sticking with a traditional IRA or 401(k) could leave you with a substantial IRS bill year after year.
With a Roth conversion, you're paying your current tax rate on the money you move over. If that current rate is lower than your anticipated future tax rate, a Roth conversion could be a no-brainer.
2. You want more flexibility in retirement
Traditional IRAs and 401(k)s eventually force savers to take required minimum distributions (RMDs). For some people, that's not a problem, because they need withdrawals from their savings to live on.
But once RMDs come into play, you may be forced to withdraw more money each year than you want or need. And since each withdrawal from a traditional IRA or 401(k) triggers a tax bill, you could end up with a headache.
A Roth conversion means you won't have to deal with RMDs. You can withdraw as much as you want to, or even leave your savings untapped any given year you don't need the money.
3. Leaving an inheritance is important to you
Traditional IRAs and 401(k)s can make estate planning more tricky. Even though you're not forced to spend your RMDs, having to remove that money from your retirement account could make it harder to arrange for an inheritance.
With a Roth IRA, you don't have to take RMDs, so you can reserve as much of your savings as you want for inheritance purposes. Plus, your heirs get 10 years to empty a Roth IRA you leave them, which gives them an opportunity to grow that money into a larger sum and enjoy tax-free withdrawals.
Time your conversion strategically
Although a Roth conversion isn't necessarily the right choice for everyone, it could pay off if any of the situations above apply to you. But if you're going to do a conversion, time it carefully.
Aim to move money over during low-income years, and spread your conversion out over several years to minimize the tax blow. With proper planning, a Roth conversion could be one of the savviest retirement moves you'll make.
