Five Windows of Opportunity for Roth Conversions

Converting a traditional IRA to a Roth IRA could be a prudent move for some people because it may provide significant tax advantages in retirement. But when are the optimal times to do a Roth conversion?

First, let’s look at some pros and cons of a Roth conversion. Unlike a traditional IRA, which is funded with pretax money, qualified withdrawals of a Roth IRA are tax-free. Another difference from traditional IRAs is that Roth IRAs aren’t subject to required minimum distributions, or RMDs (unless inherited), thus reducing your taxable income in retirement.

The catch is that you must pay income tax on the converted amount in the year you make the conversion. That’s why when considering a Roth conversion, it’s important to weigh the amount of upfront taxes, the increase to your adjusted gross income and the associated tax implications.

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Considering the money in a Roth IRA grows tax-free and is withdrawn tax-free, the tax hit up front may be worth it for some investors. For others, the added tax for the conversion may be prohibitive. Being aware of the following five windows of opportunity to make a Roth conversion may help to maximize your tax benefits.

1. When the market is down

A significant downturn in the stock market that drives the value of your portfolio down presents one of the best opportunities to do a Roth conversion. That’s because you’ll pay the conversion tax on less money. If, for example, your traditional IRA was $100,000 and dropped to $70,000 when the market fell, you’d be converting the lower amount.

The whole reason you are converting money to a Roth IRA is to be able to withdraw it tax-free in retirement. Converting when the market is down allows you to convert a larger portion of your account for the same cost. And when the market bounces back, you’ll get tax-free growth on the money you converted.

2. When you're anticipating a change in tax brackets

Income tax brackets may change after some provisions in the Tax Cuts and Jobs Act expire at the end of 2025. For example, the 22% bracket is slated to increase to 25%, and the 24% bracket will go up to 28%. With historically low tax rates right now, converting a traditional IRA or 401(k) to a Roth may make sense.

3. When you're between retirement and RMD age

For many people, their lowest annual income level will be after they retire but before RMDs begin at age 73. If they have not started taking Social Security, it may be even lower in that retirement/pre-RMD period. That time frame may provide an ideal window to take advantage of their lower income tax bracket to make a Roth conversion.

Also, remember that you don’t have to convert all of your retirement funds at one time. You can spread out those conversions over multiple years, limiting your tax hit and converting amounts that enable you to stay in your tax bracket. A common scenario could be a married couple in the 22% tax bracket. They retire at 65, but their RMDs are eight years away, and now they’re in a lower bracket until they start taking RMDs.

4. When you're in a low-income year

Earning less money in a given year than you usually do could possibly put you in a lower tax bracket, a good opportunity to convert pretax assets into a Roth. It’s often wise to wait until near the end of your low-income year to make the conversion because you’ll have a better idea of your total income and your marginal tax bracket.

5. When you're planning ahead for your heirs

A Roth conversion may be a great way to take the tax burden off your heirs. Converting from a traditional IRA to a Roth IRA allows your savings to grow unencumbered by RMDs, potentially leaving more for your heirs to withdraw tax-free. However, non-spouse beneficiaries who inherit Roth IRAs must follow IRS distribution rules and take RMDs. In some cases, heirs must withdraw all the Roth IRA funds within 10 years of the account owner’s death.

Some say timing is everything, and that may be largely true when thinking about doing a Roth conversion. Roth IRAs may be a valuable financial tool for retirement, giving you greater flexibility and potentially cutting your tax bill.

Dan Dunkin contributed to this article.

The appearances in Kiplinger were obtained through a public relations program. The columnist received assistance from a public relations firm in preparing this piece for submission to Kiplinger.com. Kiplinger was not compensated in any way.

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