There's a reason Roth conversions are often touted as a smart retirement strategy.
A Roth conversion allows you to move funds from a traditional IRA or 401(k) plan to a Roth IRA. From there, you get to enjoy all of the benefits that come with a Roth. That means your money gets to grow tax-free, you can take tax-free withdrawals, and you won't be subjected to required minimum distributions (RMDs).
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But that doesn't mean a Roth conversion is a smart choice for you. So before you move forward with one, make sure to ask yourself these key questions.
1. What tax rate am I converting at?
A Roth conversion is a taxable event. If you do a $200,000 Roth conversion, for example, you'll owe taxes on that $200,000 the year you move it over. So the key is to make sure the taxes you'll pay on a conversion are lower than the taxes you'll pay on withdrawals. If that's not the case, the conversion may not pay off.
For example, let's say you plan to work up until your RMD age and earn $100,000 a year during that time. Based on your job-related paycheck, Social Security benefits, and conversion amount, you may be looking at converting funds at a 32% federal tax rate.
But if you expect your federal tax bracket in retirement to be 22% because your paycheck from work will be gone at that point, then it doesn't make sense to pay a higher rate of tax on a conversion. In that case, you're giving the government more money.
2. Do I want to be charitable in retirement?
Another thing to consider before a Roth conversion is how charitable you want to be. QCDs, or qualified charitable distributions, allow you to send funds from an IRA to a registered charity directly. Going this route bypasses taxes but also satisfies your RMDs.
If you're going to donate a significant chunk of your savings to charity, it may not make sense to do a Roth conversion. With a conversion, you're paying taxes to move your money into a Roth when you'd potentially be avoiding taxes on that money anyway.
A Roth conversion could be a smart way to minimize taxes in retirement and gain more control over your savings by getting out of RMDs. But before you move forward, confirm that the math actually makes sense. Otherwise, you may end up regretting your decision to do a conversion after the fact.
